Extend Trade Credit Research Articles

The Determinants of Trade Credit in Transition Countries

The paper investigates the determinants of trade credit in transition countries. Traditional theories of trade credit extension suggest that both financial and commercial motives may induce non-financial companies to assume a role of financial intermediation. Furthermore, specific conditions of financing for companies in transition countries may reserve to trade credit an important role in financial structure. We test the determinants of accounts receivable and accounts payable on a sample of about 9300 companies from nine Central and Eastern European Countries. Results suggest that both financial and commercial motives explain the credit behaviour of firms. However, we do not find generalised patterns in the use of trade credit among all transition countries.

Trade credit and customer relationships

AbstractTrade credit is an important economic phenomenon, and a variety of theories have been put forward to explain the decisions firms make on credit extension. The ways in which credit can be used as a strategic tool to support corporate objectives has not, however, been fully discussed. The results presented here provide some support for the extant theory on trade credit extension and for recent empirical papers in this area (e.g. Ng et al., 1999; Petersen and Rajan, 1994). However, our results suggest that trade credit granting has a set of subtle and complex motivations over and above those predicted by standard theory. In particular trade credit extension can be used as a many‐faceted marketing/relationship management tool and/or as a means of signalling information to the market or to specific buyers about the firm, its products and its future prospects/commitment. Much of credit extension can be seen as customer focused; for example, encouraging frequent purchasers which offer the potential for relationship development or accommodating customers' demand for credit to help finance their production period. The requirements/bargaining power of large customers can influence a firm to extend more credit. Firms will vary terms in anticipation of capturing new business, to attract specific customers and in order to achieve specific marketing aims. Copyright © 2003 John Wiley & Sons, Ltd.

The trade credit decision: evidence of UK firms

AbstractTrade credit finance and credit management are gradually gaining the research attention an area of such importance merits. One area, still far from resolved, is why trade credit is extended by non‐financial firms to customers. This paper seeks to identify the generic forces behind the trade credit offer and to explore the empirical support for 20 propositions on credit motives derived from the literature and the implications of such motives to credit policies.The paper reports findings from a survey of senior finance officers involved in credit management in large UK companies. It assesses the degree to which theoretical explanations for granting trade credit are experienced in practice and whether observed differences attaching to credit motives among firms are associated with variations in credit policies and debtor days.The study found strong empirical support for seven propositions linked to competitiveness, pricing, investment and financing, and weaker support for a number of other theoretically‐derived motives for trade credit extension. Factor analysis suggested a more insightful approach to classifying trade credit motives, covering investment in customers, customer's operating and financial benefits, supplier's marketing/operational benefits and market pressure to conform. In addition, two factors—customer relations and pricing flexibility—were extracted as motives for varying credit terms. Consistent with our hypothesis average debtor days were found to be significantly higher for those firms emphasising the financing, investment, and pricing flexibility propositions. These findings, and implications for future research, are explored. Copyright © 2003 John Wiley & Sons, Ltd.

The Supply of Trade Credits: Evidence from the UK

The extension of trade credit is considered to be a form of short term financing that many firms use from both the supply and demand sides. This paper focuses on testing the theoretical determinants on trade credit and examines whether 1) creditworthy firms that have access to both external and internal financing, 2) they experience growth in profits and sales, and 3) price discrimination can actually motivated the extension of trade credit. The paper uses a large sample of data from the UK. We identify whether the decision to offer trade credit as measured by the level of account receivables depends, on firm's size. We draw a distinction between small, medium and large firms, and find evidence that the decision to extend trade credit and the relationship to the firm's ability to access finance, intermediate, or price discriminate can to a large extent be determined by the size of the firm.

Trade Credit and Product Market Competition: Theory and Evidence

Financial structure may affect output market competition. This paper analyses the strategic role played by trade credit in the determination of firms' competitive position. In a market structure in which trade relations between suppliers and retailers are governed by exclusive distribution, we show that trade credit may reduce conflicts of interest between shareholders and debt holders, and make firms compete less aggressively in the output market. We verify the empirical relevance of this strategic explanation of trade credit extension, with a sample of 40,000 couples of suppliers and clients.

Financing firms with restricted access to financial markets: the use of trade credit and factoring in Belgium

Many authors emphasize the implications of restricted access to financial markets for both small and new firms. The paper reports investigations into the use of alternative means of financing. More specifically, the use of trade credit and factoring are examined. Indeed, following the trade credit management literature both institutional and macro economic restrictions on small business finance can be overcome by ‘larger suppliers’ extending trade credit to their smaller customers. However, the DSO-rate cannot be used to measure the supplier's willingness to invest in trade credit as it depends on both suppliers' and customers' characteristics. The decision to extend trade credit is therefore approximated by the will to control its management and operationalized by the decision to factor or not to factor. The results of our study are twofold. First, factoring is mainly used by small and medium-sized companies. Moreover, when looking at the characteristics of the factor's customers, new companies facing huge capital expenditure programmes and seasonal sales decide to factor. The prejudice about factoring being a last resort means of finance is, however, not supported: companies that decide to use factoring are indeed less profitable, but this is simply due to their high growth and/or capital intensive investment programmes.

Are Pricing Practices in Japanese Channels of Distribution Finally Changing?

There is compelling evidence that the Japanese distribution system is changing. This study develops propositions regarding the expected changes in three price-related distribution practices. Data collected from 136 Japanese manufacturers and retailers in the men's apparel industry is used to describe the future direction and extent of change expected in these distribution practices. Results suggest significant changes in the system of rebates and manufacturers' suggested price but no significant change in the practice of extended trade credit.

Limited Liability in California: 1928-1931

Limited liability is generally viewed as the hallmark of the modern business enterprise. Commentators generally feel that limited liability played a major role in economic growth for the last century and a half. Recently, however, economic analyses of limited liability have focused on some potential costs associated with this regime, though most still view limited liability as optimal. Whether or not the advantages of limited liability outweigh the costs is, ultimately, an empirical question. In this paper I provide the first empirical evidence on the effect of adopting limited liability in a jurisdiction that waited until well into the 20 th century do so. I examine the effect of the change in law on incorporation rates and shareholder wealth. I also examine the political economy of change, with an eye toward the motives for the change. Overall, I find no evidence that adopting limited liability when California did, in 1931, had any significant affect on corporations or shareholders. Consistent with economic theory, the change was opposed by groups that extended trade credit. It appears that the main group that wanted to move to limited liability was the organized corporate bar in California.

Late Payment and Credit Management in the Small Firm Sector: Some Empirical Evidence

MICHAEL J. PEEL IS W1TH CARDIFF Business School, Wales, AL.Professor Nicholas Wilson is with ILeeds University Business School, England, and Carole Howorth is with Nottingham University Business School, England. Based on the results of a qtuestionnlaire survey, this paper provides some new evidence relating to late payment and credit and working capital m-ianiagenment practices of a sample of 211 small businesses operating in the United Kingdom manufacturing sector. Small firnms are often suppliers of trade credit, despite the difficulties that this often causes them, and there is little empirical evidence on the credit granting decisions of smiall firnms. Theory suggests that firms facing a higher cost of institutional credit (i.e. small firms) are less likely to offer trade credit. Empirical evidence suggests that not only do small firms provide trade credit to their customers but they often finid themselves providing extended trade credit (i.e. are paid after the due dlate( late). It is clear that exten-dedI tu ade ((re(lit plays anl important signallinig' rol(e t'0o smaller- firms wishing to gaini sales anlt establish reputationi. This paper examtillIc. the extent of late payntient 1or stniall suippliers and the cit-t-ent pt acti(es ill tr-ade credit managenmenit. The kex restilts indicate that thei-e was large suppor t amiong respondenits for the cut rrent I JK legislation giving small firms the statuittot J right to initerest orn late payments, xvitlt such legislation being rated tlhe illost popular measuire to reduce late pax'lntelltt and also the highest rated factot- associated wtih improving busilless performance. Inproved credit attd financial management was, however, rated of relatively low import in this respect. In total, 59.5 pet cenit, of respondents stated that late paimet-tt posed an important or very iml1portall-it problem to their- businesses, wvitih 43. 1 pct l cent Oiving a similar resp)ttsi ts c espC of bad debts. 89 per cent indicated that they paid their own suppliers late to a greater or lesser extent. The amount of working capital management undertaken was found to be related to the severity of the problem for individual firms (i.e. necessity was driving action). Responses from the sample firms were found to differ significantly with respect to firm size; larger small firms had a worse late payment problem and consequently had to do more in the way of 'back-end' credit management (i.e. collection, analysis of late payment and debtor days). However, there was barely any support for credit management training among this sub-group. The smaller (micro) firms had a lesser late payment problem and subsequently did less 'back-end' credit management but were more concerned with various aspects of institutional finance. It was posited that the problems faced by small firms are at least partly associated with business size and with the life cycle of the firm.

A Strategic Approach on Organizing Accounts Receivable Management: Some Empirical Evidence

In this paper, the organizational behavior in managing accounts receivable is studied. It is based on the recent surge of interest in trade credit management from both academics and practitioners emphasizing 1) the rather permanent character of these short-term but continuously renewed investments and 2) their strategic potential due to the existence of financial, tax-based, operating, transaction and pricing motives. The paper focuses on a search for sources of such a strategic value and for the determinants of its risk. More specifically this potential strategic value is said to create a need for flexibility and control in managing accounts receivable. It will therefore induce a need for internalization of its management. The resulting risks, however, favor its externalization. This results in a revision of the existing decision-making processes since, the extension of trade credit becoming a strategic asset, investments in accounts receivable cannot be judged by the financial needs incurred as measured by the traditional DSO-rate anymore. More specifically, a transaction cost theoretic approach is used to explain the decision whether or not to internalize the firm's accounts receivable management and its risk, resulting in a set of hypotheses to be tested on a sample of both large and medium-sized Belgian companies.

Inertial credit and opportunistic arrears in transition

In a transition economy, enterprise restructuring may exhibit a Laffer-curve response to tighter credit as a result of rational collective inertia. In the presence of a rigid production structure, unenforceable contracts and high adjustment costs, a contraction in credit finance subtracts more liquidity than enterprises can generate internally. Because unrestructured firms are forced to extend trade credit to illiquid buyers, an increase in their number increases the availability of forced supplier credit, in turn increasing the attractiveness of inertial behavior. As trade credit cannot be enforced, a critical mass of trade and wage arrears causes pressure for a collective bailout, thus validating inertial behavior even by reformable firms.

Degradables

This paper investigates the link between a firm's customer-base concentration and stock return volatility. We find that firms with more concentrated customer bases have higher idiosyncratic volatility. Further, we show significant variation in customer-base concentration effects across customer and supplier firm dimensions, including customer type, customer default probability, customer idiosyncratic volatility, customer customer-base concentration, extended trade credit, and industry product market competition. Our results are robust to potential endogeneity concerns, different estimation methodologies and volatility measures, among numerous other robustness checks. Overall, our results contribute to the understanding of idiosyncratic volatility sources in firm stock returns and provide new evidence on the transmission of firm-specific shocks in a supply-chain network environment.

An empirical examination of organizational structure: The economics of the factoring decision

Sellers who extend trade credit to their business customers choose whether to integrate the management of trade credit or to enter into specialized factoring contracts. Using original data from a broad cross-section of firms we test a model of this decision. The model is based on a theory of the firm that stresses transactions costs (including information costs) as determinants of vertical integration. Consistent with expectations, we find that specificity of assets to the buyer-seller relationship is negatively related to the decision to factor and that factors are more likely to be used when information and monitoring costs are high.

A Credit Limit Decision Model for Inventory Floor Planning and Other Extended Trade Credit Arrangements*

ABSTRACTThis paper analyzes the dealership credit limit problem in terms of the valuation of a Markov process of cash flows with sequential credit decisions over an infinite planning horizon. The formulation distinguishes between the upper bound on credit applicable at the account formation stage and the upper bound applicable to periodic reorders. The result is a closed form solution to the problem which serves as a criterion function for approving or denying credit on a customer‐by‐customer basis.Data for a sample of manufacturing firms are employed to estimate typical ranges for criterion function parameters. Upper bounds on credit limits are then calculated and graphically presented for median parameter values as well as for values at the 5th and 95th percentiles for the sample data. Finally, an empirical study is conducted of actual trade credit extended by firms. The results support the hypothesis that the variables in the decision model are important determinants of the amount of trade credit outstanding.

A Pure Financial Explanation for Trade Credit

This paper provided a pure financial explanation for the existence of trade credit and for the values of the credit terms offered to customers. Two motives for extending trade credit were identified. The pure operating flexibility motive arises because the opportunity to change credit policy provides the seller an efficient way to respond to fluctuations in demand. This motive was eliminated from consideration in this paper by assuming constant demand. The seller must hold a liquid reserve when the financial markets are imperfect and the desire to earn an excess rate of return on this reserve explains the pure financial intermediary motive for trade credit.The pure financial incentive to lend this liquid reserve to customers was examined by viewing a market borrowing rate of interest that exceeds the market lending rate of interest as a hindrance to trade or, equivalently, as a financial market tariff. This tariff imposes a wedge between the market prices paid and received for the product plus a loan and thereby inflicts a loss of surplus on the seller and buyers. Trade credit lending enables the seller and/or the buyers to recapture at least part of this loss when the source of the tariff does not apply to direct loans to customers. Financial market tariffs caused by transactions costs fulfill this requirement because the trade credit lender's familiarity with its customers and product provide it with information and collection cost advantages over financial intermediaries. Tariffs caused by financial intermediary rents fulfill this requirement as well because the parties to a trade credit loan do not employ the services of a financial intermediary.Increasing opportunity costs and financial market imperfections in addition to the ones described above establish the limits of credit policy. The optimal amount of accounts receivable is derived from the condition that the marginal revenue of trade credit lending is equal to the marginal cost. This condition combined with factoring costs produces a unique, finite optimal credit period. Accrual accounting for income tax purposes imposes an additional restriction because the firm is taxed on the recovery of its opportunity costs. These limitations on credit policy were examined separately in this paper for clarity but they are in effect simultaneously in practice.

The Effect of Trade Credit on Price and Price Level Comparisons

THE comparison of prices and price levels is an important ingredient in many economic forecasts, policy prescriptions and empirical academic studies. For example, prices charged by a firm for domestic sales are compared with those charged on exports to substantiate charges of dumping. Differences in national price levels are also used in place of real foreign exchange rates as more stable and appropriate translators for international comparisons of such macroeconomic indicators as gross national product or per capita income. On the domestic side, temporal comparisons of individual prices and their contributions to a high and volatile inflation rate have been cited by advocates of wage and price controls and an oil consumption tax, and comparisons of prices, price levels, and exchange rates are at the center of academic controversies over the validity of the law of one price and the purchasing power parity theory. The fundamental assumption underlying these investigations is that the goods or services under comparison are identical. This assumption has proven troublesome because differences in product characteristics such as quality, service support, and delivery availability are difficult to identify and value; they are also generally specific, in size and character, to a product or industry. Further, it may be difficult to see the relationship between these qualitative characteristics and macroeconomic variables, a relationship that, once established, might simplify the identification and measurement of product differences. As a result, the effect of differences in product quality on comparisons of prices is commonly ignored or assumed random or stable. However, one product quality-extended trade credit-can be measured easily because it is neither random nor stable. It also has the desirable trait of being systematically related to several macroeconomic variables: the cost of extending trade credit is a function of interest rates and expected inflation-a correlation that allows us to recognize the importance of trade credit in some price comparison applications. It is possible to use this relationship to adjust prices and price levels for the extension of trade credit. More importantly, some price comparisons may be substantially affected by the adjustment. This paper describes a model linking transactions prices and trade credit. It demonstrates that the prices of identical goods will differ, even in perfectly efficient markets for goods and capital, if credit terms differ. As a result, apparent arbitrage profits may disappear when prices are adjusted for the value of trade credit extended to finance the goods. One major component is the length of time for which trade credit is extended. Within a single economy different explicit or implied credit maturities translate into different credit costs. In turn, these costs are reflected in price differences. A good example is the recent use of merchant discounts for cash payments as a disincentive against credit card payment. The amount of the discount is directly related to the merchants' cost of funds. When prices are compared internationally, another element is added. Variations in the cost of credit extended in different currencies may reflect differences in interest rates and expected inflation. When compared at the current exchange rate the national prices of goods sold on credit should differ by the variation in the cost of providing that credit. The reflection of trade credit in the relationship between prices, exchange rates, and interest rates has several interesting implications. For example, the increased rate of inflation normally expected after a devaluation may not present itself if it has been reflected in transactions prices prior to devaluation; when devaluation occurs the domestic inflationary response may seem unReceived for publication June 12, 1980. Revision accepted for publication February 18, 1981. * Duke University. I am grateful for helpful comments from Jacob Frenkel, John Hekman, Richard Levich, Stephen Magee, David Mullins, Rachel McCulloch, Aris Protopapadakis, and William White. I received additional suggestions from the International Trade Workshop of the Harvard Economics Department. Support for this work from the Associates of the Harvard Business School is gratefully acknowledged.

Monetary Policy and the Extension of Trade Credit

Monetary Policy and the Extension of Trade Credit

Monetary Policy and Fluctuations in the Extension of Trade Credit

Monetary Policy and Fluctuations in the Extension of Trade Credit

MONETARY POLICY AND FLUCTUATIONS IN THE EXTENSION OF TRADE CREDIT*

MONETARY POLICY AND FLUCTUATIONS IN THE EXTENSION OF TRADE CREDIT*

Mercantile Credit, Monetary Policy, and Size of Firms

IN the continuing debate about the role of money, credit, and monetary policy in our society, one of the major issues centers around the specific incidence of on individual business firms. On the one hand, leading proponents of monetary controls as a regulatory device have emphasized the general, impersonal nature of such controls. They have argued that the impact of monetary policy is determined by the reaction of individual borrowers to changed market conditions. On the other hand, critics of general controls have suggested that institutional changes have led to discrimination by suppliers in the market for money and Differences in size of firm, market structure, or type of industry, the amount of liquid assets which firms may accumulate, imperfections in the capital markets, and a variety of other institutional phenomena have been offered as reasons for the failure of monetary policy to operate as a general, impersonal, control device. Some of these institutional restrictions have been summarized under the general heading of rationing. Both conjecture and empirical observation of the structure of bank loans have suggested that credit rationing favors large firms.' But those who suggest that this is the case ignore important institutional arrangements that work in the opposite direction. Banks and financial institutions are not the only sources of credit for small firms. The existence of a large volume of interfirm (mercantile) credit makes it apparent that business firms borrow from each other.2 Variations in the volume and distribution of mercantile credit are important accompaniments of monetary policy changes. During the recent tight money period, for example, the increase in mercantile credit by the manufacturing sector was three times larger than the increase in the money supply (currency plus adjusted demand deposits). We show below that, when money was tightened, firms with relatively large cash balances increased the average length of time for which credit was extended. And this extension of trade credit appears to have favored these firms against whom credit rationing is said to discriminate. Hence the credit provided by banks and financial institutions seems to have been redistributed to restore much of the general, impersonal nature of monetary controls during I955-57. Moreover, the reduction in cash balances by liquid firms helps to explain the increase in the income velocity of money during the recent tight money period. The following section examines the relationship between a measure of monetary tightness and the liquidity of manufacturing firms of varying size. Section II discusses the important factors influencing the allocation of trade Section III points out differences in the sources and allocation of funds for large and small firms during I955-57 and compares the impor* I appreciate the assistance and helpful suggestions of my colleagues G. L. Bach, R. M. Cyert, David Granick, and Edwin Mansfield, who read earlier drafts of this paper. This research was supported by grants of the Carnegie Institute of Technology Graduate School of Industrial Administration from the School's research funds and from funds provided by the Ford Foundation for the study of organizational behavior. 'Professor W. L. Smith has suggested that small firms ''are more dependent on the banking system than large firms are, have fewer alternative sources of funds, and seem in general to be more vulnerable to the effects of tight credit. Compendium of Papers Submitted by Panelists Before the Joint Economic Committee, March 3I, I958, 505-506. Over a year earlier, the Committee had summarized the situation as follows: Chairman Patman: It is the little fellow that is hurt, and the big fellow is not hurt at all. Monetary Policy: I955-56, Hearing before the Subcommittee on Economic Stabilization of the Joint Economic Committee, December io and ii, I956, 34-35. See also J. K. Galbraith, Market Structure and Stabilization Policy, this REVIEW, XXXIX (May I957), I24-33. 2 Lending by suppliers to their customers through the extension of trade credit has long been recognized as a form of interfirm relationship. Sayers and Foulke have noted that one of the prime reasons for the development of mercantile credit in the nineteenth century was the need of merchants to obtain short-term credits in circumstances under which banks did not lend. R. S. Sayers, Central Banking in the Light of Recent British and American Experience, Quarterly Journal of Economics, Lxiii (May I949); R. Foulke, Behind the Scenes of Business, Dun and Bradstreet, I937.