Financial Constraints and Trade Credit as a Strategic Tool: Evidence from Small-Scale Reservation Reforms in India
69 Pages Posted: 25 Sep 2015 Last revised: 17 Oct 2017
Date Written: October 17, 2017
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 power, (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 11% more trade credit and lowers prices by 8.6% when facing an increased threat of entry. Interestingly, firms with deeper pockets offer longer terms on trade credit, while 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. Thus, emphasize the role of trade credit as a strategic tool to defend market power when firms face financial constraints.
Keywords: Trade credit, limit-pricing, entry threat, financial constraints
JEL Classification: G32, G38
Suggested Citation: Suggested Citation