Trade Credit or Financial Credit? An International Study of the Choice and Its Influences

ABSTRACT

Trade credit financing has usually been assumed to be an expensive source of funds. Recent studies, however, suggested that it can be available at either low or no cost. Using an international panel of firms, we provide an empirical answer to this matter. We analyze the type of firms and financial environments that are associated with a relatively more intense use of financial credit and, consistent with the mainstream literature, we find that trade credit financing is chosen by firms that have more restricted access to financial credit. These results appear to be stronger for firms located in emerging markets.

KEYWORDS:

• trade credit
• trade payables
• emerging markets

Notes

1. The reported values are cross-section and time series averages, but in countries like Slovakia or Ecuador, trade credit exceeds 20% of the value of the assets.

2. A commonly used example of terms of trade “2/10 Net 30” means that paying in 10 days an invoice due in 30 will generate a 2% discount for the debtor; this implies an annualized discount above 43% (see Smith (1987) and Ng, Smith, and Smith (1999) among many others).

3. Molina and Preve (2012), studying the effect of financial distress on the use of trade credit in US firms, find that financially distressed companies that increase their use of trade credit from suppliers experience declines in performance of more than 11% (compared with distressed firms that do not rely on trade credit). This has been interpreted as evidence that trade credit is an expensive source of financing.

4. These two approaches are fundamentally different, since the research questions differ substantially. While Demirguc-Kunt and Maksimovic (2001) focus on predicting whether the legal and banking infrastructure actually predict the use of trade credit—concluding on the complementarity of trade and financial credit, our article uses macro- and firm-level data with focus on understanding firm-level choice between trade credit and financial credit, as a function of access to financing. Thus, the former is more an economic and policy focus study, and the latter is a corporate finance one. In fact, it is interesting to notice that both articles obtain congruent results using different databases through different time spans and models.

5. Sample firms must have revenues and net assets exceeding zero. Moreover, observations with negative values for trade receivables and payables, and inventory are deleted.

6. Only the ratio Cash Flow to Assets was trimmed 5% at the left tail due to a higher presence of outliers.

7. This variable should be defined as trade credit from suppliers / daily purchases; unfortunately, the data on purchases is unavailable in the data source, and following standard practice, we scale payables with CGS instead. Given that the sample is not restricted to positive observations of the DPO ratio, the estimations are not subject to sample selection bias, in which case we would be required to perform Heckman-type regressions.

8. i.e. an estimate of account payable scaled by total assets could distort the specific focus of our analysis, as there are many issues affecting total assets that are not necessarily linked to the dynamic / operation of the firm that generates trade credit.

9. The UK is considered as a standalone region instead of being included with the rest of the European countries because its financial system is clearly different from those prevailing in continental Europe.

10. We follow the IMF classification.

11. Thus, we refer to a broader concept than the strict definition of financial constraints.

12. With correlations:

13. As a robustness check, we also run the corresponding regressions using the traditional coefficient of variation in revenues as an alternative volatility proxy.

14. Additionally, as suggested by Antov and Atanasova (2007), banks may rely on suppliers’ financing as a way to screen trustworthy customers. This would imply that firms gain a side benefit from using expensive trade credit as a means of better access to financial credit.

15. We will explain in the next section the econometric approach for the estimation of these and subsequent models.

16. In countries with weaker institutions, banks are typically less prone to meet the financial needs of fragile firms.

17. We thank the anonymous reviewer for this suggestion.

18. Given the time-invariant characteristic of these variables in our sample, we include a less-demanding set of fixed effects.

19. We thank anonymous referees for suggesting this robustness test, which provides more confidence for the results of this article. For space reasons (and similarity of results), the corresponding table is omitted, but remains available upon request.