Impact of trade credit on supply chains with downgraded customers

Abstract

Trade credit is the liquidity provision from suppliers to customers. In this paper, we examine the use of trade credit in the supply chain after customer firm's credit rating being downgraded. We find that trade credit is likely to decrease after customers getting downgraded credit ratings. We further show that suppliers and customers will be both better off in profitability if trade credit increases following customers' credit rating downgrades. Given that the use of trade credit generally has a significant positive effect on suppliers' and customers' profitability, we show that this effect is stronger when customers receive credit rating downgrades. The empirical evidence in our paper suggests that strengthening the financial collaborations in the supply chain is a superior strategy relative to shrinking the financial collaborations under the circumstance that customer firms suffer from a growing financial constraint and financial distress.