Threat of Entry: Trade Credit and the Defense of Market Power

Abstract

Do incumbent supplier firms facing increased threat of entry by competitors adjust trade credit to respond to such threats? Threatened incumbent supplier firms may extend more trade credit, ex-ante, to defend their market power, or they may reduce trade credit as enforcement of such informal credit contracts is expected to become more difficult with the expected decline in market power. I test these contrasting predictions by exploiting plausibly exogenous, staggered removals of product level entry barriers for Indian manufacturing firms, and find that an average incumbent supplier firm extends 10% more trade credit with increased threat of entry, supporting the first hypothesis. My results are particularly strong for firms manufacturing differentiated products, where reduction in price mark-ups may not be an effective strategy, thereby bringing into focus the role of trade credit as a strategic tool to defend market power.