The Implicit Costs of Trade Credit Borrowing by Large Firms
55 Pages Posted: 16 Mar 2012 Last revised: 13 Sep 2013
Date Written: June 26, 2013
We examine a novel but economically important characterization of trade credit relationships in which large investment-grade buyers borrow from their substantially smaller, often credit- constrained, suppliers. Using variation in large retailers’ aggregate cash management policies as a shock to how quickly individual vendors are paid, we show that slower payment terms by important buyers are linked to cutbacks in important expenditures at the supplier level. By way of example, a one month delay in payment by Wal-Mart is associated with 1.2% reduction in capital expenditures for the representative Wal-Mart supplier. We find limited evidence of adjustment along financial margins. The effects are sharpest during periods of tight bank credit and for firms which we might otherwise characterize as facing credit constraints, suggesting that the opportunity cost of extending credit to one’s buyers is positive and increasing in the financial frictions facing a firm. Meanwhile, using novel data on warranty claims and the length of buyer-supplier relationships, we find support for the hypothesis that uncertainty regarding product quality for new suppliers drives slow payment, in spite of the dead weight losses it imposes on these often constrained firms. Thus, the simultaneous financial and product market frictions commonly facing small, young firms may make trade credit extension both necessary and costly.
Keywords: Trade credit, investment
JEL Classification: G32
Suggested Citation: Suggested Citation