Abstract: Many firms have capital constraint, especially the small and medium sized enterprises. In recent years, supply chain finance plays an important role in solving capital constraint problems and has received a great deal of attention. In this paper, a two-echelon supply chain consisting of single supplier and single capital constraint retailer facing uncertain market demand is studied. The retailer purchases from the supplier and the supplier offers short-term credit loan as well as an option contract to the retailer. By building a Stackelberg game model and through backward induction analyses, the supplier's optimal decisions on option price and interest rate, and the retailer's corresponding optimal ordering and financing decisions are examined. Our results show that when the supplier's production cost is lower than a threshold, a stable equilibrium between the supplier and retailer can be achieved and the optimal order size is greater than a certain number q_α, where q_α satisfies q_αf(q_α)/(1-F(q_α))=1. Under this circumstance, both the supplier and retailer enjoy positive expected profit. When the supplier's production cost is higher than a threshold, the supplier will set high option price and interest rate to absorb all the expected profit in the supply chain, and the optimal order size is less than q_α. However, under this circumstance, the retailer gets zero expected profit from selling and suffers from high bankruptcy risk, therefore the equilibrium is unstable. To reach a stable state, the supplier has to decrease either the option price or interest rate to provide the retailer with positive marginal profit, and then the optimal order size converges to q_α but still greater than q_α. It is also found that even if an option contract cannot coordinate the decentralized supply chain in the presence of capital constraint, it improves the supply chain's performance compared with a wholesale price contract. Several managerial insights are provided in this paper.First,when the downstream retailer has capital constraint, it is optimal for the upstream supplier to offer it short-term loan. Second, when the retailer has severe capital constraint and purchases with the money from short-term loan, it may take risky actions, i.e., keep its order size at a high level. Therefore, the supplier, who offers the short-term loan, should pay close attention to the retailer's actions and keep its bankruptcy risk under control. Finally, compared with awholesale price contract, an option contract can improve the supply chain efficiency in the presence of capital constraint.

Key words: supply chain, capital constraint, trade credit financing, option contracts