An agency model to explain trade credit policy and empirical evidence

Abstract

This article explains trade credit policy based on the agency theory. According to this theory, we have developed an agency model based on the adverse selection and moral hazard phenomena arising from the relation between sellers and buyers. This model has been estimated by using panel data methodology applied to UK companies. Our findings strongly support the model proposed. We find that smaller firms, those with a smaller proportion of fixed assets, and those that are less profitable extend more trade credit, whereas firms with a high proportion of variable costs and high percentage of bad debts extend less.

Acknowledgements

We are grateful to an anonymous referee for helpful comments. We thank the research agency of the Spanish Government, DGI (Project SEJ2004-06627) and the Junta de Castilla y Leon (Project SA079A05) for financial support.

Notes

¹ These authors have made a decompositional analysis of capital structure for UK companies. According to them, determinants of gearing depends on the measure used to proxy it and consequently, depend on which component of debt is being analysed. Their evidence shows that results are very sensitive to whether or not trade credit is included.

² We calculate the PQL variable as follows: PQL = (30/(1 + SIZE)) for technical industries, PQL = (0.5/(1 + SIZE)) for perishable industries and PQL = (2/(1 + SIZE)) for the remaining firms. The figures 30, 0.5 and 2 have been chosen in order to give more power to the first characteristic related to industry, as suggested in financial literature. However, note that the second characteristic (size) plays an important role, since it distributes the values within each kind of industry and provides variability to PQL, which is necessary when using panel data methodology. More details will be provided by the authors upon request.

³ The earlier-mentioned variables related to the adverse selection phenomenon show the expected relationships with the dependent variable; however, the PQL and DPA variables are not significant. Therefore, results from regressions do not allow us to affirm that firms categorized as high-tech producers extend more credit than others and that high-quality firms are prone to increase the trade credit offered to their clients in order to use this argument to require more trade credit from their suppliers.

⁴ This variable is calculated as the sum of long-term debt and debt in current liabilities as a percentage of total assets.