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In-kind finance: a theory of trade credit
01 Jun 2004-Research Papers in Economics (London School of Economics and Political Science, LSE Library)-
TL;DR: In this paper, the authors argue that it is typically less profitable for an opportunistic borrower to divert inputs than to divert cash, and that suppliers may lend more liberally than banks.
Abstract: It is typically less profitable for an opportunistic borrower to divert inputs than to divert cash. Therefore, suppliers may lend more liberally than banks. This simple argument is at the core of our contract theoretic model of trade credit in competitive markets. The model implies that trade credit and bank credit can be either complements or substitutes. Among other things, the model explains why trade credit has short maturity, why trade credit is more prevalent in less developed credit markets, and why accounts payable of large unrated firms are more countercyclical than those of small firms.
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TL;DR: In this article, the authors propose a more complete conceptual framework for analysis of SME credit availability issues, and emphasize a causal chain from policy to financial structures, which affect the feasibility and profitability of different lending technologies.
Abstract: We propose a more complete conceptual framework for analysis of SME credit availability issues. In this framework, lending technologies are the key conduit through which government policies and national financial structures affect credit availability. We emphasize a causal chain from policy to financial structures, which affect the feasibility and profitability of different lending technologies. These technologies, in turn, have important effects on SME credit availability. Financial structures include the presence of different financial institution types and the conditions under which they operate. Lending technologies include several transactions technologies plus relationship lending. We argue that the framework implicit in most of the literature is oversimplified, neglects key elements of the chain, and often yields misleading conclusions. A common oversimplification is the treatment of transactions technologies as a homogeneous group, unsuitable for serving informationally opaque SMEs, and a frequent misleading conclusion is that large institutions are disadvantaged in lending to opaque SMEs.
1,706 citations
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TL;DR: In this paper, the authors use a broad range of contractual information to assess the empirical relevance of different financial theories of trade credit and propose a novel identifying strategy that exploits this insight to analyse the trade credit volume and the contract terms.
Abstract: We use a broad range of contractual information to assess the empirical relevance of different financial theories of trade credit. The common feature of all financial theories is that suppliers have an advantage over other lenders in financing credit-constrained firms. While the reasons for the financing advantage differ across theories, they are usually related either to product characteristics or to market structure. We propose a novel identifying strategy that exploits this insight to analyse the trade credit volume and the contract terms. Our analysis suggests that the most important product characteristic for explaining trade credit volume and contract terms is the ease with which the seller’s product can be diverted. Market power in input and output markets also contributes to explain trade credit patterns.
585 citations
TL;DR: In this article, the interaction between the financial and the industrial aspects of the supplier-customer relationship is examined and the implications of the model are examined empirically using parametric and nonparametric techniques on a panel of UK firms.
Abstract: There are two fundamental puzzles about trade credit: why does it appear to be so expensive, and why do input suppliers engage in the business of lending money? This paper addresses and answers both questions analysing the interaction between the financial and the industrial aspects of the supplier-customer relationship. It examines how, in a context of limited enforceability of contracts, suppliers may have a comparative advantage over banks in lending to their customers because they hold the extra threat of stopping the supply of intermediate goods. Suppliers may also act as liquidity providers, providing insurance against liquidity shocks that may endanger the survival of their customer relationships. The relatively high implicit interest rates of trade credit result from the existence of insurance and default premia. The implications of the model are examined empirically using parametric and nonparametric techniques on a panel of UK firms.
577 citations
TL;DR: A supply chain with a retailer and a supplier is considered, where a newsvendor-like retailer has a single opportunity to order a product from a supplier to satisfy future uncertain demand and both the retailer and supplier are capital constrained and in need of short-term financing.
Abstract: We consider a supply chain with a retailer and a supplier: A newsvendor-like retailer has a single opportunity to order a product from a supplier to satisfy future uncertain demand. Both the retailer and supplier are capital constrained and in need of short-term financing. In the presence of bankruptcy risks for both the retailer and supplier, we model their strategic interaction as a Stackelberg game with the supplier as the leader. We use the supplier early payment discount scheme as a decision framework to analyze all decisions involved in optimally structuring the trade credit contract (discounted wholesale price if paying early, financing rate if delaying payment) from the supplier's perspective. Under mild assumptions we conclude that a risk-neutral supplier should always finance the retailer at rates less than or equal to the risk-free rate. The retailer, if offered an optimally structured trade credit contract, will always prefer supplier financing to bank financing. Furthermore, under optimal trade credit contracts, both the supplier's profit and supply chain efficiency improve, and the retailer might improve his profits relative to under bank financing (or equivalently, a rich retailer under wholesale price contracts), depending on his current “wealth” (working capital and collateral).
516 citations
TL;DR: In this paper, the effect of the 2007-2008 financial crisis on between-firm liquidity provision was studied. But the authors focused on the effect on the trade credit taken by constrained firms.
406 citations
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TL;DR: In this article, the authors predict that corporate borrowing is inversely related to the proportion of market value accounted for by real options and rationalize other aspects of corporate borrowing behavior, such as the practice of matching maturities of assets and debt liabilities.
12,521 citations
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TL;DR: In this paper, the authors investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries and find that factors identified by previous studies as important in determining the cross-section of the capital structure in the U.S. affect firm leverage in other countries as well.
Abstract: We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that factors identified by previous studies as important in determining the cross- section of capital structure in the U.S. affect firm leverage in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.
5,935 citations
TL;DR: In this article, a general model of the firm is developed, and then the financial structure of firms, debt collecting and bankruptcy is analyzed in greater depth, and the authors contribute to contact theory as developed in economic analysis.
Abstract: This essay contributes to contact theory as it has been developed in economic analysis, particularly in the context of the firm. It develops a general model of the firm, and then analyzes in greater depth the financial structure of firms, debt collecting and bankruptcy.
3,585 citations
TL;DR: The authors showed that the extent of competition in credit markets is important in determining the value of lending relationships and that creditors are more likely to finance credit constrained firms when credit markets are concentrated because it is easier for these creditors to internalize the benefits of assisting the firms.
Abstract: This paper provides a simple model showing that the extent of competition in credit markets is important in determining the value of lending relationships. Creditors are more likely to finance credit constrained firms when credit markets are concentrated because it is easier for these creditors to internalize the benefits of assisting the firms. The model has implications about the availability and the price of credit as firms age in different markets. The paper offers evidence for these implications from small business data. It concludes with conjectures on the costs and benefits of liberalizing financial markets, as well as the timing of such reforms.
3,259 citations
TL;DR: In this article, the authors propose a more complete conceptual framework for analysis of SME credit availability issues, and emphasize a causal chain from policy to financial structures, which affect the feasibility and profitability of different lending technologies.
Abstract: We propose a more complete conceptual framework for analysis of SME credit availability issues. In this framework, lending technologies are the key conduit through which government policies and national financial structures affect credit availability. We emphasize a causal chain from policy to financial structures, which affect the feasibility and profitability of different lending technologies. These technologies, in turn, have important effects on SME credit availability. Financial structures include the presence of different financial institution types and the conditions under which they operate. Lending technologies include several transactions technologies plus relationship lending. We argue that the framework implicit in most of the literature is oversimplified, neglects key elements of the chain, and often yields misleading conclusions. A common oversimplification is the treatment of transactions technologies as a homogeneous group, unsuitable for serving informationally opaque SMEs, and a frequent misleading conclusion is that large institutions are disadvantaged in lending to opaque SMEs.
1,706 citations