Differential Effects of Received Trade Credit and Provided Trade Credit on Firm Value

Abstract

With over half a trillion dollars in trade credit flowing between firms in the United States, it is critically important for managers to understand how the trade credit that their firm receives and provides affect its value. Trade credit is a strategic investment in supply chain relationships that allows the recipient to make payment later rather than at the time of the sale. A firm provides trade credit to its downstream business customers and also receives trade credit from its upstream suppliers. Although research has shown that provided trade credit builds a firm's shareholder value, it has not examined what effect, if any, received trade credit has on the firm's value. As a result, one might assume that received trade credit affects firm value in the same manner as provided trade credit. We argue otherwise and show that received trade credit and provided trade credit have differential effects on firm value. Received trade credit has a negative direct effect and a positive indirect effect (through profit), whereas provided trade credit has a positive direct effect and a negative indirect effect. The difference in direct effects hinges on the disparate nature of dependence in the supply chain. Provided trade credit increases customers' dependence on the firm, building the firm's value. In contrast, received trade credit increases the firm's dependence on its suppliers, destroying the firm's value. Empirical results using a sample of 2804 firms from 1986 to 2017 provide robust support for the hypotheses. They show that managers risk overestimating the value of a 1 SD increase in received (provided) trade credit by $284.74 ($74.95) million, on average, if they do not consider both the direct and indirect effects it has on their firm's value.