Trade Credit Contracts

Abstract

This paper provides new evidence on the unique role of trade credit and contracting terms as a way for both sellers and buyers to mange business risk. We use a novel and unique dataset on almost 30,000 supplier contracts for 56 large buyers and over 24,000 suppliers in Europe and North America. Our sample of buyers and suppliers include firms of varying size, investment grade, and sectors. We find evidence in support of four important, and not mutually exclusive, reasons for trade credit: 1) As a method of financing; 2) As a means of price discrimination; 3) As a bond assuring buyers of product quality; and 4) As a screening mechanism to gauge buyer default risk. In particular, we find that the largest and most creditworthy buyers receive contracts with the longest maturities, as measured by net days, from smaller, investment grade suppliers. In comparison, early payment discounts seem to be used as a risk management tool to limit the potential nonpayment risk of trade credit. In particular, early payment discounts are generally offered to smaller, non-investment grade buyers. Our results suggest that contract terms are jointly determined by supplier and buyer characteristics.

Keywords: Trade Credit, Capital Structure, Contract Theory, Risk Management

JEL Classification: G32