Financial Contracting and Organizational Form: Evidence from the Regulation of Trade Credit

Abstract

We present evidence that restrictions to the set of feasible financial contracts affect buyer - supplier relationships and the organizational form of the firm. We exploit a regulation that restricted the maturity of the trade credit contracts that a large retailer could sign with some of its small suppliers. Using a within-product differences-in-differences identification strategy, we find that the restriction reduces the likelihood of trade by 11 percentage points. The large retailer also responds by internalizing procurement to its own subsidiaries and reducing overall purchases. Finally, we find evidence that relational contracts can help mitigate the inability to extend long trade credit terms.

Keywords: Organizational Form, Trade Credit, Vertical Integration

JEL Classification: D23, G30, L14, L15, L22