Financing strategy of transnational supply chain with vertical shareholding under tax system difference: Creditor or guarantor?

https://doi.org/10.1016/j.tre.2022.102973Get rights and content

Highlights

  • Examines the operations–finance interaction in a transnational supply chain.

  • Firm’s taxable income varies under different tax systems.

  • Tax and vertical shareholding have dramatic effects on firms’ financing decisions.

  • The results illustrate how firms implement these conclusions in practice.

Abstract

Economic globalization enhances the international effect of income tax collection, which significantly impacts the taxable income and cash flow management of a transnational supply chain. This study investigates the financing preferences of the buyer and supplier in a transnational supply chain with vertical shareholding under tax symmetry and asymmetry. The buyer can act as a creditor to provide early payment financing or as a guarantor to help the supplier obtain a low-interest loan. We construct Stackelberg game models to determine the buyer’s and supplier’s equilibrium decisions and profits in two financing strategies under different tax systems. The results indicate that the buyer and supplier have inconsistent financing preferences when the supplier cannot borrow directly from the bank. The buyer always prefers to be a creditor, whereas the supplier’s financing preference depends on the trade-off between the sales revenue, production cost, financing interest, tax cost, and dividends. Surprisingly, we find an optimal shareholding ratio interval related to tax rates that can eliminate double marginalization under tax symmetry, and the supply chain can be more profitable than that under centralized decision-making. However, double marginalization cannot be eliminated under tax asymmetry. The results suggest management implications for the financing strategy choice and operational decisions of a transnational supply chain with vertical shareholding.

Introduction

Economic globalization has intensified income internationalization, which enhances the international effect of income tax collection. Most countries, including China, the U.S., Norway, Korea, and Mexico, permit tax-loss carryforward, but only a few, such as the U.S. and Norway, allow tax-loss carryback. When only tax-loss carryforward applies, firms lose out on interest and opportunities due to delayed (uncertain) future compensation. Tax-loss carryback means that a firm can deduct its loss in the current period from prior profit to realize a partial tax rebate, equivalent to a tax subsidy. Tax symmetry occurs when profits are taxed at a specific rate and losses are subsidized at the same rate (Eldor and Zilcha, 2002, Xiao et al., 2015). Tax asymmetry occurs when profits are taxed at a specific rate but losses are not subsidized (Lu and Wu, 2020, Schneider et al., 2021). Each country’s tax system demonstrates an apparent asymmetry between taxation on profits and compensation for losses, significantly impacting firms’ taxable incomes and cash flow management in transnational supply chains.

As an essential measure of supplier relationships and cash flow management – vertical shareholding – is common and significantly impacts transnational supply chains. To manage the transnational supplier relationship and raise performance, buyers usually hold a proportion of the suppliers’ equity through investment such as equity strategic alliances (ESAs). Mi achieves supply chain management by investing in suppliers such as Amlogic.1 Walmart boosts energy efficiency by investing in Plug Power and owns a 17% stake.2 Honda, a leading Japanese automaker, announced in 2020 that it would invest in Chinese electric vehicle battery maker Contemporary Amperex Technology (Xiao et al., 2021). Further, vertical shareholding in a transnational supply chain can offer tax-saving opportunities for firms such as multinational firms (MNFs). Cooper and Nguyen (2020) reveal that taxes became the largest expenditure for firms. Firms can achieve tax savings through cash flow management methods such as trade credit (Desai et al., 2016) and transfer pricing (Kumar et al., 2021). However, existing research on tax savings in supply chains considers only tax rate differences, though the differences in tax systems affect taxable income. Particularly, due to tax differences, the wholesale price under a financing strategy has the property of a transfer price, which provides firms with tax savings opportunities.

Given the long cycle of transnational procurement and settlement, the supplier accumulates a high accounts receivable, resulting in capital constraints, an essential practical problem in transnational supply chains. Procter & Gamble extended its payment terms for all suppliers by 30 days in 2013, leading to capital constraints for some suppliers (Kouvelis and Xu, 2021). In the international market, capital constraints restrict a supply chain’s operational decisions (Tang et al., 2018), thus affecting the supply chain’s efficiency. Specifically, if a supplier cannot smooth production or provide timely delivery due to such constraints, the buyer will face a supply shortage risk or supply interruption, which negatively affects the supply chain. Chrysler temporarily closed four assembly plants after a supplier, Plastech, filed for bankruptcy protection because it lacked funds, resulting in a parts shortage (Zhao and Huchzermeier, 2019).

According to the World Bank Group Enterprise Surveys,3 27% of 130,000 firms across 135 countries identify “access to finance” as a major business constraint. A capital-constrained supplier can apply for loans directly from a bank (DBF). However, suppliers in transnational supply chains are generally small- and medium-sized enterprises (SMEs), and most are located in developing countries (Chen et al., 2020). They typically have a weak competitive position as they lack sound management mechanisms and financial systems. Banks are either wary of providing financing to SMEs or applying higher interest rates. The International Finance Corporation estimates that 65 million firms, or 40% of formal SMEs in developing countries, have an unmet financing need of $5.2 trillion annually, which is equivalent to 1.4 times the current level of global SME lending.4

Because of the limited financing channels in developing countries or high-interest rates, buyers must help capital-constrained suppliers obtain financing or provide financing directly. Buyers can act as guarantors to help suppliers obtain (low-interest rate) loans from banks; that is, through the guaranteed bank financing (GBF) channel. Mi guarantees bank financing for its suppliers (some of which are part-owned by Mi, such as Amlogic) through the full-chain financing platform.5 Most milk farmers obtain financing from commercial banks on a guarantee by Yili.6 Buyers can also provide a buyer financing channel as creditors to make a partial early payment (EPF) of the procurement cost to ensure that the supplier can fulfill the contract demands. EPF constituted 19%–22% of global trade finance in 2008 (Zhao and Huchzermeier, 2019). Walmart allows Plug Power to obtain advance payments at a lower cost, making Plug Power’s future transactions with Walmart cash flow positive up front.7 BMW and PSA pay parts suppliers in advance (Yan et al., 2020). As previously mentioned, wholesale prices in transnational supply chains with different tax systems and offering different financing strategies have transfer price properties. Nevertheless, existing research on the operations–finance interface rarely considers taxes (Lu and Wu, 2020), and only a few scholars (Lu and Wu, 2020, He et al., 2022) examine the financing decisions of MNFs or transnational supply chains under tax rate differences. The properties of tax symmetry and asymmetry show marked differences between countries. Hence, the choice of financing strategy for transnational supply chains with vertical shareholding is an interesting question. To the best of our knowledge, the effect of tax system differences on the financing preference of the buyer as a creditor or guarantor in a transnational supply chain with vertical shareholding has hitherto remained uninvestigated.

In this context, we focus on how tax system differences affect a transnational supply chain’s operational decisions and financing strategies given the supplier’s capital constraints. We also examine the influence of the shareholding ratio. Specifically, we try to answer three questions:

  • (i)

    What is the buyer’s financing preference under different tax systems: guarantor (GBF), creditor (EPF), or nothing (DBF)?

  • (ii)

    What is the supplier’s financing strategy selection under different tax systems?

  • (iii)

    How do the joint forces of tax differences and vertical shareholding influence firms’ financing preferences and a transnational supply chain’s profit?

Few studies explore supply chain finance in a transnational supply chain context (Xu et al., 2018). This study is thus novel as it extends the research scope of supply chain finance to the global environment. First, we focus on the financing strategy selection of a transnational supply chain. Specifically, when faced with a capital-constrained supplier, will the foreign buyer act as a guarantor, or a creditor, or do nothing? We also explore the financing strategy selection of the supplier. Second, we analyze the impact of tax rates in different countries and investigate the influence of tax system differences on the financing strategy and operational decisions of the transnational supply chain. Third, the results illustrate the impact of vertical shareholding on the operations–finance interface. We determine the equilibrium financing strategy interval with respect to the shareholding ratio. Our findings lead to recommendations for the financing strategy and operational decisions of transnational supply chain with vertical shareholding (such as ESAs and MNFs) under tax differences.

The remainder of this paper is organized as follows. Section 2 provides a literature review. Section 3 focuses on the problem description and model formulation. Sections 4 Tax symmetry, 5 Tax asymmetry construct the decision-making model under tax symmetry and asymmetry, respectively. Section 6 explores the influence of tax differences and vertical shareholding on operational decisions and profits, and deduces the financing strategy selection. Section 7 discusses the effects of other factors. Section 8 concludes and provides managerial insights.

Section snippets

Literature review

The three literature streams related to our study focus on tax and transnational supply chain management, shareholding supply chain management, and the operations–finance interface.

Problem description and model formulation

The tax system of each country shows a clear asymmetry between the taxation of profits and subsidies for losses (Eldor and Zilcha, 2002). Tax symmetry is a relatively ideal environment that symmetrically deals with firms’ losses and profits. The tax rate τ applies to the firm’s pre-tax profit, whether it is positive or negative; that is, the firm pays a tax rate of τ when it is profitable, and it receives a subsidy at the same rate τ for its loss (Xiao et al., 2015). Under tax asymmetry, the

Direct bank financing

As in Section 3.1, the bank’s interest rate is rD=rf+wDcQD0L(QD)F(ξ)dξ. The supplier’s decision variable is QD. His wholesale revenue is wDmin(ξ,QD), production cost is cQD, and financing interest is cQDrD. The supplier’s pre-tax profit is TsD=[wDmin(ξ,QD)cQD(1+rD)]+, and the tax cost is τ1TsD. As the dividends are paid after tax, the supplier is required to pay λ(1τ1)TsD to the buyer. The supplier’s expected after-tax profit function is ΠsD=E[(1λ)(1τ1)TsD].

The buyer’s decision variable

Direct bank financing

Consistent with tax symmetry, the bank’s interest rate is rDA=rf+wDAcQDA0L(QDA)F(ξ)dξ. The supplier’s decision variable is QDA, and the pre-tax profit is TsDA=[wDAmin(ξ,QDA)cQDA(1+rDA)]+. His expected profit function is ΠsDA=E[(1λ)(1τ1)TsDA].

The buyer’s decision variable is wDA. Her pre-tax profit is TbDA=(pwDA)min(QDA,ξ). By the definition of tax asymmetry, the buyer’s expected profit function is ΠbDA=E[TbDAτ2(TbDA)++λ(1τ1)TsDA].Because of pwDA, the buyer’s taxable income is greater

Discussion and managerial analysis

In this section, we first analyze the influence of tax difference and vertical shareholding on equilibrium decisions and profits. We then compare the equilibrium decisions and firms’ profits under tax symmetry and asymmetry. To save space, we present the proofs in Online Appendix. We also derive the buyer’s and supplier’s financing preferences.

Extension

Conclusions

A transnational supply chain operates in different tax environments. We discuss the financing strategy selection and operational decisions of a transnational supply chain with differing tax system in mind. To this end, we establish a transnational supply chain’s financing model where a buyer purchases from a capital-constrained supplier under either tax symmetry and tax asymmetry. The buyer can act as a guarantor to assist the supplier in acquiring low-interest GBF or provide EPF directly as a

CRediT authorship contribution statement

Mengyu He: Conceptualization, Methodology, Software, Formal analysis, Visualization, Writing – original draft, Writing – review & editing. Kai Kang: Conceptualization, Methodology, Investigation, Writing – review & editing, Project administration, Funding acquisition. Xuguang Wei: Resources, Visualization, Investigation, Writing – review & editing, Funding acquisition. Yongjian Li: Visualization, Investigation, Validation, Writing – review & editing, Supervision, Funding.

Declaration of Competing Interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Acknowledgments

The authors sincerely thank the editor and the anonymous reviewers for their constructive comments on this paper.

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    This work was supported by the National Office for Philosophy and Social Sciences of China [Grant Nos. 14BGL055, 17CGL004].

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