Ex Ante Bargaining and Ex Post Enforcement in Trade Credit Supply: Theory and Evidence from China

Abstract

If payment of goods is easily default, economic transaction may deeply suffer from the risk. This risky environment formed a mechanism that governs how economic transaction is realized, subsequently how trade credit is given. This paper distinguished ex ante bargaining and ex post enforcement, then modeled that bargaining power reduces trade credit ex ante, and ex post enforcement power and cash in hand of buyer can enhance both trade amount and trade credit in a presence of default risk. We modeled this relationship in order to organize findings from previous literature and from our original micro data on detailed transaction in China to consistently understand the mechanism governing trade credit. Then tested empirically a structure from the theoretical prediction with data. Results show that the ex post enforcement power of seller mainly determines size of trade credit and trade amount, cash in hand of the buyer can substitute with enforcement power; Bargaining power of seller is exercised to reduce trade credit and trade amount for avoiding default risk, but it simultaneously improves enforcement power as well. We found that ex post enforcement power consists of (ex ante) bargaining power on between two parties and intervention from the third party. However, its magnitude is far smaller than the direct impact to reduce trade credit and trade amount.