Jiri Chod

Resource Flexibility with Responsive Pricing

This article studies two types of flexibility used by firms to better respond to uncertain market conditions: resource flexibility and responsive pricing. We consider a situation in which a single flexible resource can be used to satisfy two distinct demand classes. While the resource capacity must be decided based on uncertain demand functions, the resource allocation as well as the pricing decision are made based on the realized demand functions.We characterize the effects of two key drivers of flexibility: demand variability and demand correlation, assuming normally distributed demand curve intercepts. Demand variability creates opportunity costs and, with fixed prices, decreases the firms profit. We show that with the additional flexibility gained from responsive pricing, the firm can maximize the benefits of favorable demand conditions and mitigate the effects of poor demand conditions, ultimately profiting from variability. Positive demand correlation, on the other hand, remains undesirable under responsive pricing. The optimal capacity of the flexible resource is always increasing in both demand variability and demand correlation. This contrasts with the scenarios based on fixed prices, highlighting the crucial difference that responsive pricing makes in the management of flexible resources. We further quantify the value of flexibility for the firm and its customers by considering, as a benchmark, a firm relying on two dedicated resources. The value of flexibility is most significant if the demand levels are highly variable and negatively correlated. In such cases, the firm benefits from demand variability due to responsive pricing, while facing limited demand risk due to resource flexibility. Finally, we endogenize the input price of the flexible resource by considering the pricing decision of the resource supplier.

Operational Flexibility and Financial Hedging: Complements or Substitutes?

We consider a firm that invests in capacity under demand uncertainty and thus faces two related but distinct types of risk: mismatch between capacity and demand and profit variability. Whereas mismatch risk can be mitigated with greater operational flexibility, profit variability can be reduced through financial hedging. We show that the relationship between these two risk mitigating strategies depends on the type of flexibility: Product flexibility and financial hedging tend to be complements (substitutes)---i.e., product flexibility tends to increase (decrease) the value of financial hedging, and, vice versa, financial hedging tends to increase (decrease) the value of product flexibility---when product demands are positively (negatively) correlated. In contrast to product flexibility, postponement flexibility is a substitute to financial hedging as intuitively expected. Although our analytical results assume perfect flexibility and perfect hedging and rely on a linear approximation of the value of hedging, we validate their robustness in an extensive numerical study.

Strategic IPOs and product market competition

We examine firms’ incentives to go public in the presence of product market competition. As a result of their greater ability to diversify idiosyncratic risk in the capital market, public firms’ owners tolerate higher profit variability than owners of private firms. Consequently, public firms adopt riskier and more aggressive output market strategies than private firms, which improves the competitive position of the former visa-vis the latter. This strategic benefit of being public, and thus, the proportion of public firms in an industry, is shown to be positively related to the degree of competitive interaction among firms in the output market, to demand uncertainty, and to the idiosyncratic portion of this uncertainty. Additional empirical predictions concern the effect of a firm’s initial public offering on its market share and on its rivals’ valuations. We test the model’s predictions and find empirical support for most of them. & 2010 Elsevier B.V. All rights reserved.

Resource Flexibility and Capital Structure

This paper examines how the optimal investment in the capacity of flexible and nonflexible resources is affected by financial leverage and, conversely, how a firms resource flexibility affects its optimal capital structure. We consider a two-product firm that invests in the optimal capacity of product-flexible and product-dedicated resources in the presence of demand uncertainty. Before investing in capacity, the firm issues the optimal amount of debt, trading off the tax benefit and lower transaction cost of debt financing against the cost of financial distress and the agency cost associated with leverage. We show that in the presence of debt, resource flexibility has benefits in addition to reducing the mismatch between supply and demand. Namely, resource flexibility mitigates the shareholder--debtholder agency conflict as well as the risk of costly default. Most interestingly, we show that resource flexibility mitigates the underinvestment problem because it reduces the probability that a firm will go bankrupt with some of its capacity being fully utilized. When lenders anticipate that a firm will choose a relatively flexible capacity mix, they should provide more favorable credit terms, to which the firm should respond by issuing more debt. The main empirical predictions are that resource flexibility is negatively related to the cost of borrowing and positively related to debt. This paper was accepted by Yossi Aviv, operations management.

Inventory, Risk Shifting, and Trade Credit

This article has two objectives. First, it shows how debt financing distorts the inventory decision of a retailer who orders multiple items that differ in cost, revenue, or demand parameters. Taking advantage of limited liability, a debt-financed retailer will favor items with a low salvage value, those with a high profit margin, and those that represent a large proportion of the total inventory investment. Second, we argue that this distortion is mitigated when financing is provided by the supplier(s) who can observe the actual order quantities before determining the credit terms. “Borrowing goods” rather than “borrowing cash” limits the retailer’s ability to deviate from the first-best inventory decision. This benefit of trade credit financing is most significant when sourcing multiple differentiated items from a single supplier, and when bankruptcy risk and, thus, the limited liability effect are considerable.

The Value of Flexibility in Make-to-Order Systems: The Effect of Demand Correlation

We consider a manufacturer of mass-customized modular products who orders components under demand uncertainty, and sets prices, produces to order, and trades excess components in a secondary market after this uncertainty is resolved. The sequence of events reflects, in a parsimonious fashion, the considerable reduction in demand uncertainty between the procurement stage and the selling season, typical of industries with long supply lead times and short product life cycles. We prove that, in contrast to conventional wisdom, the value of production flexibility and expected profit increase with demand correlation if, and only if, commonality between the corresponding products does not exceed a threshold. We also prove that the value of flexibility and expected profit may each increase or decrease with demand variability, depending on demand correlations and component commonalities across the entire product line. Finally, we prove that when demand shocks are independent, the optimal product prices are positively correlated if, and only if, the degree of commonality between the corresponding products exceeds a threshold.

A Theory of ICOs: Diversification, Agency, and Information Asymmetry

This paper develops a theory of financing of entrepreneurial ventures via crypto tokens, which is not limited to platform-based ventures. We compare token financing with traditional equity financing, focusing on agency problems and information asymmetry frictions associated with the two financing methods, as well as on risk sharing between entrepreneurs and investors. Token financing introduces an agency problem not present under equity financing -- underproduction, while mitigating an agency problem often associated with equity financing -- entrepreneurial effort underprovision. Our theory abstracts from all institutional and potentially transient differences between tokens and equity and is based on a single intrinsic characteristic of tokens -- they represent claims to a ventures output. We show that tokens are likely to dominate equity for ventures developing information goods or services, those for which entrepreneurial effort is crucial, and/or those with relatively low payoff volatility. In addition, tokens have can have an advantage over equity in signaling venture quality to outside investors.

Agency Cost of Debt: A Case for Supplier Financing

In this paper, we first show how debt financing distorts the inventory decision of a multi–product retail firm. Protected by limited liability, a debt–financed retailer seeks risk by favoring items with a low salvage value, those with a high profit margin, and those that represent a large share of the total inventory investment. Second, we demonstrate that in many cases, this distortion can be avoided by using supplier financing. A supplier who automatically observes the retailer’s order quantities, can deter risk–seeking behavior on the part of the retailer with the threat of stricter credit terms. This provides suppliers with a financing advantage over banks, which can monitor inventory only at a cost.

Trade Credit and Supplier Competition

This paper examines how competition among suppliers affects their willingness to provide trade credit financing. Trade credit extended by a supplier to a cash constrained retailer allows the latter to increase cash purchases from its other suppliers, leading to a free rider problem. A supplier that represents a smaller share of the retailers purchases internalizes a smaller part of the benefit from increased spending by the retailer and, as a result, extends less trade credit relative to its sales. In consequence, retailers with dispersed suppliers obtain less trade credit than those whose suppliers are more concentrated. The free rider problem is especially detrimental to a trade creditor when the free-riding suppliers are its product market competitors, leading to a negative relation between product substitutability among suppliers to a given retailer and trade credit that the former provide to the latter. We test the model using both simulated and real data. The estimated relations are consistent with the models predictions and are statistically and economically significant.