Trade Receivables Policy of Distressed Firms and its Effect on the Costs of Financial Distress

Abstract

This paper studies the trade receivables policy of distressed firms as the trade off between the firm's willingness to gain sales and the firm's need for cash. We find that firms increase trade receivables when they have profitability problems prior entering financial distress, but reduce trade receivables when they have cash flow problems in financial distress. We also find that a firm that significantly cuts its trade receivables when in financial distress will have an additional 7% drop in sales and stock returns over the previously documented 24% average drop for a firm in financial distress. Moreover, the performance decline of a firm in financial distress is significantly higher if the firm cuts trade receivables than if it does not.

Keywords: Trade Credit, Trade Receivables, Financial Distress

JEL Classification: G31, G33