Abstract
Statistics show that the sale of goods on credit is widespread among firms even when they are capital constrained and thus face relatively high costs in providing trade credit. This study provides an explanation for this by arguing that customers who possess strong market power are able to increase their customer surplus by demanding to purchase the goods on credit. This gain in customer surplus increases with the degree of asymmetric information between buyer and seller with respect to product quality. Therefore, firms that are perceived as risky are especially subject to the market power of the customer and have to sell their goods on credit. Using detailed firm-level data from a large number of firms in Eastern Europe and Central Asia, this study finds evidence consistent with this hypothesis. It finds a strong positive correlation between customer market power and trade credit provision. Furthermore, this relationship is especially strong when the supplier is more risky and in countries with limited financial sector development or a weak legal system.
Highlights
Trade credit is created whenever a supplier offers terms that allow the buyer to delay payment
The main focus of this paper is to test whether customers exert their market power to buy their goods on credit in order to lessen asymmetric information problems concerning product quality
The result could reflect the fact that suppliers are more willing to provide more trade credit to customers with strong market power because they are more creditworthy firms
Summary
Trade credit is created whenever a supplier offers terms that allow the buyer to delay payment. As the gain in customer surplus is especially large when the exchange relationship is perceived as more risky, customers will especially exert their market power and buy goods on credit when a supplier firm is small and located in a less developed country. This explains why these firms, even if they are capital constrained, are providing more trade credit to their clients. This relationship is especially strong when the supplier is more risky and in countries with limited institutional development These results suggest that customers use their market power to buy goods on credit as a way to increase their customer surplus.
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