Trade Credit Policy in Long-Term Supply Contracts

Posted: 16 Jan 2014

See all articles by Anna M. Costello

Anna M. Costello

University of Michigan, Stephen M. Ross School of Business

Date Written: January 14, 2014

Abstract

This study explores the role of trade credit using a unique sample of long-term supply contracts collected from SEC filings. The contracts provide rich detail of the variation in the types and amounts of credit, as well as buyer and supplier characteristics and other product market variables. I provide evidence that the role of trade credit changes over the life of the trade relationship. Financing terms in first-time trade contracts help to mitigate adverse selection; when information asymmetry about product quality is high, suppliers extend longer days payable to allow buyers time to inspect products before payment. In established relationships, trade credit serves a financing role; lending decisions adjust to the respective exposure of suppliers and buyers to financial constraints. As credit flows from the least to the most financially constrained firms, I find that (i) product prices adjust and (ii) the investment of financially constrained firms increases. Overall, the results suggest that the role of trade credit varies based on the type of relationship involved.

Suggested Citation

Costello, Anna M., Trade Credit Policy in Long-Term Supply Contracts (January 14, 2014). Available at SSRN: https://ssrn.com/abstract=2379118

Anna M. Costello (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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