Enemy at the Gates: Trade Credit v/s Price Discount as a Strategic Tool

Abstract

How do financial constraints affect an incumbent supplier firm's choice of extending more trade credit versus offering price discounts when facing an increased threat of entry from competitors? The threatened incumbent supplier firms may (a) extend more trade credit, ex-ante, to defend their market share, (b) reduce prices, or (c) do both. I test these predictions by exploiting plausibly exogenous, staggered removals of product-level entry barriers for Indian manufacturing firms. I find that the average incumbent supplier firm extends 7.9% more trade credit and lowers prices by 9.1% when facing an increased threat of entry. Interestingly, firms with deeper pockets offer longer terms on trade credit, while financially constrained firms rely on price discounts. Also, I find that financially constrained customers accept credit offers, while unconstrained customers accept price discounts. I further confirm my results using various proxies for financial constraints and policy changes in the country that improved access to finance. Overall, I find trade credit as an effective strategic tool to defend market share.

Keywords: Trade credit, limit-pricing, entry threat, financial constraints

JEL Classification: G32, G38