Abstract
The paper investigates the determinants of bank and trade credit demands and their interactions with the input combination optimally chosen by the entrepreneur, within an incomplete contract setting with uncertainty, two-input technology and collateralized credit contracts. Besides the traditional financing motive, the paper isolates two other reasons for trade credit demand: trade credit provides commitment to the otherwise unobservable input combination specified in the bank contract and it is taken for liquidation motive. The paper provides a theoretical foundation for several stylized facts for which the extant literature lacks a clear understanding: (1) why suppliers do not traditionally lend cash; (2) why wealthy firms, unconstrained on bank credit, ask for trade credit; (3) why, in some circumstances, suppliers have the full priority in repossessing the collateral assets in case of bankruptcy; (4) why firms located in countries with a weaker creditor protection invest relatively more in tangible assets.
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