Bank Loans, Trade Credits, and Borrower Characteristics: Theory and Empirical Analysis*

Abstract

Trade credit is vendor financing offered by a supplier to increase the sale of its product. Trade credit prevails among riskier borrowers, in competing with bank loans in the corporate loan market. The present paper models the economic incentive for product suppliers to extend trade credits to relatively riskier borrowing firms that might not be able to obtain financing from commercial banks. When there exist positive markups due to imperfectness of the input market, an input supplier can increase sales and profits by offering trade credits to facilitate the sale of inputs to riskier borrowing firms who cannot obtain bank financing. Therefore, in the corporate debt market, trade credits tend to service riskier borrowing firms rather than bank loans. The empirical analyses using Compustat and Loan Pricing Corporation DealScan data support the theoretical prediction that a riskier borrower seeks more trade credit financing, independent of bank loan access.