Taxes and trade credit: Evidence from the 2017 tax cuts and jobs act

Abstract

AbstractIn this study, we examine the effect of taxes on the use of trade credit and on the relation between trade credit financing and managerial inside debt using the Tax Cuts and Jobs Act of 2017 TCJA (TCJA). We find that firms are likely to use more trade credit after the enactment of the TCJA, supporting the tax‐based hypothesis for the existence of trade credit. Furthermore, firms with higher CEO inside debt tend to use less trade credit than those with lower CEO inside debt. The negative relation between inside debt and trade credit is less pronounced after the TCJA enactment. These results are consistent with our conjecture that CEOs with high inside debt are less inclined to use trade credit, which is an expensive source of external financing, and firms use trade credit to reallocate capital for more efficient uses in response to lower tax rates. Our findings suggest that taxes and managerial debt‐based compensation might be relevant factors influencing firms’ trade credit policy.