On the Role of Receivables in Managing Salesforce Incentives

ABSTRACT

Despite the obvious problems associated with collections, firms routinely sell on credit. Conventional wisdom suggests offering credit is a necessary evil when dealing with insistent cash-constrained customers. This paper provides a more positive view of trade credit. We find that offering credit can enhance the efficiency of incentive contracts with sales personnel. In effect, with a credit sale, a client gets a second chance to generate enough cash. The client's second chance gives the sales agent another opportunity to demonstrate his past diligence to the firm. Moreover, to limit the risk associated with the fact that even a high-quality client may fail to eventually come up with funds, the firm relies on the accrual system. In particular, the agent's (discretionary and early) choice of the bad debt allowance conveys his private information regarding client quality; the payments associated with subsequent collections/default keep such reporting in check.

Notes

1. A prominent example is the flood of receivable write-offs in the high-tech sector in companies such as Lucent, Cisco, Gateway, Qualcomm (Wall Street Journal, 13 July 2001).

2. There are, of course, other explanations for credit sales. Suppliers may choose to offer credit instead of deferring to financial institutions because they have better abilities to assess client creditworthiness, better control over client activities or better ability to dispose of collateral in the event of default (e.g. Petersen and Rajan, 1997). Credit sales may also be a de facto means of price discrimination by essentially providing discounts to low-quality clients (Brennan et al., 1988).

3. Throughout the paper, we assume the agent effort disutility is small enough that the principal elects to motivate a _H.

4. Note the dimension of the agent's message space (report may be A ₁ or A ₂) is rich enough to convey the agent's private information since client quality too is a binary variable (type may be θ₁ or θ₂). Hence, from an incentive perspective, there is no reason for the principal to employ discriminatory credit practices (e.g. instruct the agent to issue credit only to a θ₂-type client).