Trade credit: the paradox

As already mentioned in our previous blogpost, we have shifted our focus to the difference in trade credit between public and private firms. It’s a fact that public firms have easier access to external financing and have more bargaining power than private firms. These are some of the reasons why this kind of firms don’t need that much trade credit as a private firm. For a private firm, trade credit is an important way of financing. They do not possess the same possibilities as a public firm.

Of course the needs of the private firms for trade credit are not always fulfilled by their suppliers. There is always a risk for them by giving more trade credit to a certain client. Giving a private firm more trade credit involves more risk than allocating this credit to a public firm. A way to measure this risk is to look at the cost of capital. This cost is lower for public firms.

By summarizing the two previous paragraphs, we’ve arrived to our paradox. Private firms need trade credit but because of the higher risk, they do not always receive the extended payment period they actually need. A public firm on the other hand has the possibility to obtain other ways of financing more easy. Due to this, their demand for trade credit is lower than the demand of private firms. This leads to the question: “which kind of firm makes use of trade credit the most?”. The answer to this question is not that obvious due to the paradox. Briefly summarized, the demand from private firms is higher than from public but the offer is lower. Only through empirical evidence we will get a clear answer to our question and a solution for the paradox.

Source: Journal of Corporate Finance Volume 46, October 2017, Pages 391-410