What You Sell is What You Lend? Explaining Trade Credit Contracts

TLDR: In this article, 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 analyze 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 analyze 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.

Figures

Table 2. The volume of trade credit

Table 2. The volume of trade credit

Table 3. Contract terms

Table 2. The volume of trade credit

Table 4. Payables and payment behavior

Full text

Mariassunta Giannetti, Mike Burkart and Tore Ellingsen
What you sell is what you lend? Explaining
trade credit contracts
Article (Accepted version)
(Refereed)
Original citation:
Giannetti, Mariassunta, Burkart, Mike and Ellingsen, Tore (2011) What you sell is what you lend?
Explaining trade credit contracts. The Review of Financial Studies, 24 (4). pp. 1261-1298. ISSN
0893-9454
DOI: 10.1093/rfs/hhn096
© 2008 The Author
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What You Sell Is What You Lend?
Explaining Trade Credit Contracts

Mariassunta Giannetti
Stockholm School of Economics,
CEPR and ECGI
Mike Burkart
Stockholm School of Economics,
London School of Economics,
CEPR, ECGI and FMG
Tore Ellingsen
Stockholm School of Economics,
and CEPR

We thank two anonymous referees, Allan Berger, Mike Cooper, Hans Degryse, Paolo Fulghieri (the editor),
Ron Masulis, Mitchell Petersen, Greg Udell and seminar participants at the RFS Conference on The Financ ial
Management of Financial Intermediaries (Wharton), the European Finance Association (Zurich), the CEPR Sum-
mer Symposium in Financial Markets, the Chicago Fed Bank Structure Conference, the ECB Conference on Cor-
porate Finance and Monetary Policy, The Financial Intermediation Research Society Conference (Shanghai), th e
University of Utah, Tilburg University, Norwegian Scho ol of Management and Business Administration (Bergen),
the World Bank, the Bank of Sweden, and the Stockholm School of Economics for their comments. Financial sup-
port from the Jan Wallander och Tom Hedelius Foundation (Giannetti), the Riksbankens Jubileumsfond (Burkart
and Ellingsen) and the Torsten and Ragnar Söderbe rg Foundation (Ellingsen) is gratefully acknowledged. Address
correspondence to: Mariassu nta Giannetti, Stockholm School of Economics, Box 6501, SE— 113 83 Stockholm,
Sweden; telephone: +46-8-7369607, email: mariassunta.giannetti@hhs.se.

Abstract
We relate trade credit to product characteristics and aspects of bank-…rm relationships and document
three main empirical regularities. First, the use of trade credit is assoc iated with the nature of the
transacted good. In particular, suppliers of di¤erentiated products and services have larger accounts
receivable than suppliers of standardized goods and …rms buying more services receive cheaper trade
credit for longer periods. Second, …rms receiving trade credit secure …nancing from relatively unin-
formed banks. Third, a majority of the …rms in our sample appears to receive trade credit at low cost.
Additionally, …rms that are more creditworthy and have some buyer market power receive larger early
payment discounts.
JEL classification: G32.
Keywords: Trade credit, contract theory, collateral, moral hazard

Trade credit is an important source of funds for most …rms and is considered to be crucial for …rms
that are running out of bank credit.
1
Previous empirical work has primarily investigated how the
borrower’s performance and …nancial health a¤ect the volume of trade credit. We broaden the analysis
in two directions. First, we show how trade credit usage is correlated not only with the …rm’s balance
sheet position, but also with the characteristics of the traded product and with the buyer’s banking
relationships. Second, we analyze both trade credit volumes and contract terms. Overall, while our
…ndings provide some support for existing trade credit the ories, they also challenge received wisdom.
Relating trade credit to th e nature of the inputs and banking relationships enables us to uncover
three novel empirical regularities about trade credit use and practice in the United States.
The …rst empirical regularity is that the use of trade credit is associated with the nature of the
transacted good. More speci…cally, after controlling for deb t capacity, suppliers of di¤erentiated products
and services have larger accounts receivable than suppliers of standardized goods. Service suppliers also
appear to o¤er cheaper trade credit for longer periods, and do not refuse lending on the basis of the
buyer’s creditworthiness.
This …rst set of results demonstrates the empirical relevance of theories that implicitly attribute
trade credit to product characteristics. As we argue, these explanations have in common that the prod-
ucts sold on credit are not homogeneous o¤-the-shelf goo d s, but each proposes a di¤erent economic
mechanism. Overall, the empirical evidence lends most support to theories maintaining that suppli-
ers are less concerned about borrower opportunism either because of strong customer relationships or
because of the low diversion value of some inputs. Suppliers of services and di¤erentiated products
may be hard to replace because they provide unique or highly customized inputs. The consequent high
switching costs make buyers reluctant to break up relationships and thus less tempted to default on
these suppliers [Cunat (2007)]. Hen ce, suppliers of services and di¤erentiated prod uc ts should be more
3

willing to sell on credit than suppliers of standardized products.
Di¤erentiated products and services are also more di¢ cult or even impossible to d ivert for unintended
purposes. While standardized products command a market p rice and can be easily sold to many di¤erent
users, resale revenues may be low for di¤erentiated goods because it may be hard to identify suitable
buyers and there is no reference price. Services are virtually impossible to resell. This shou ld contribute
to shield suppliers of di¤erentiated goods and services against buyer opportunism [Burkart and Ellingsen
(2004)] in the same way as strong relationships with customers do.
Other theories that also implicitly associate trade credit with non-stand ardized goods …nd limited
support in the data. First, di¤erentiated goods are more often tailored to the needs of particular
customers. Original suppliers can redeploy these goods better than other lenders following buyer def ault
because the y know the pool of potential alternative buyers or because they can modify the goods more
easily to the needs of other customers. Hence, these goods should be sold on credit [Longhofer and
Santos (2003); and Frank and Maksimovic (2004)]. This theory appears incapable of accounting for the
widespread use of trade credit in the United States, not least because of the suppliers’limited ability
to repossess the good. In case of default, U.S. laws allow suppliers to repossess the goo d only within
10 days since delivery,
2
whereas in our sample the maturity of trade credit typically exceeds 10 days.
Additionally, this theory cannot explain why service suppliers are inclined to provide trade credit as
services have no collateral value.
Second, di¤erentiated products and services tend to have more quality variation, making buyers
more reluctant to pay before having had time to inspect the merchandise or ascertained the quality of
services [Smith (1987)].
3
However, we …nd that suppliers’reputations do not decrease their propensity
to o¤er trade credit.
Finally, other theories propose that suppliers may be concerned with losing crucial customers and
4

Frequently asked questions

Q1. What have the authors contributed in "What you sell is what you lend? explaining trade credit contracts" ?

First, the authors show how trade credit usage is correlated not only with the rm’s balance sheet position, but also with the characteristics of the traded product and with the buyer’s banking relationships. Second, the authors analyze both trade credit volumes and contract terms. As the authors argue, these explanations have in common that the products sold on credit are not homogeneous o¤-the-shelf goods, but each proposes a di¤erent economic mechanism. 

Q2. What are the future works in "What you sell is what you lend? explaining trade credit contracts" ?

In this subsection, the authors discuss ( 1 ) to what extent their estimates are consistent with other trade credit theories and ( 2 ) to what extent these theories could provide alternative explanations for the previous ndings. As the authors have no information on how services are provided, they can not fully disregard this possibility. In particular, rms that are more prone to extend trade credit namely, rms in the services and di¤erentiated good industries do so by o¤ering longer payment periods and fewer discounts, thereby enabling their customers to use trade credit nance to a larger extent and at lower cost. A challenge for future theoretical work is to explain why sellers do not simply lower the price to these customers instead. 

Q3. How low is the eective rate behind early payment discounts?

More relevant for small rms, the National Association of Credit Management estimates that the e¤ective rates behind early payment discounts can be as low as 3% [Miwa and Ramseyer (2002)]. 

Q4. How do suppliers enforce their due dates?

In order to enforce their due dates, suppliers may impose a penalty for late payment even if they do not allow purchases on account: 

Q5. What is the reason why large rms are able to take advantage of their suppliers?

Given that large rms ought to have better access to other sources of credit, a possible explanation is again that suppliers concede discounts to large rms even after the discount period has elapsed.