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Self-Enforcing Trade Credit

35 Pages Posted: 29 Aug 2012 Last revised: 10 Mar 2017

Marta Troya-Martinez

New Economic School (NES); Centre for Economic Policy Research (CEPR)

Date Written: February 28, 2017

Abstract

Trade credit plays a very important role in inter-firm transactions. Because formal contracts are often unavailable, it is granted within an ongoing relationship. We characterize the optimal self-enforcing contract, when the ability to repay is unknown to the supplier and the threat of trade suspension is used to discipline the buyer. The optimal contract resembles a debt contract: if the fixed repayment is met, the contract is renewed. Otherwise, the supplier demands the highest feasible repayment and suspends trade for some time. The length of the trade suspension is contingent on the repayment. We provide a novel explanation for why the quantity is undersupplied, even when a repayment is met.

Keywords: Relational contracts, trade credit, imperfect monitoring, debt contract

JEL Classification: C73, D82, L14

Suggested Citation

Troya-Martinez, Marta, Self-Enforcing Trade Credit (February 28, 2017). International Journal of Industrial Organization, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2138203 or http://dx.doi.org/10.2139/ssrn.2138203

Marta Troya-Martinez (Contact Author)

New Economic School (NES) ( email )

100A Novaya Street
Moscow, Skolkovo 143026
Russia

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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