Customer relationships and the provision of trade credit during a recession

Abstract

Having a close relationship with a customer that accounts for a relatively high proportion of sales may be costly for small suppliers and weaken their bargaining power. Suppliers with a weak bargaining position may then find it difficult to reduce their provision of trade credit during a recession despite the need to do so. Employing Japanese small business data, we conclude that close customer relationships are in fact beneficial (not costly) for small suppliers in trade credit contracts. First, we find that small suppliers tend to offer less trade credit during a recession, even if the supplier–customer relationship is close. Second, notwithstanding a close supplier–customer relationship, we find that small suppliers offer less trade credit to their main customers if the supplier is in financial distress or charged higher interest rates by banks.

Keywords:

• Trade credit
• customer–supplier relationship
• bargaining power
• small business

JEL Classification:

• G32
• G20

Acknowledgements

This study was conducted as one of the projects of the Corporate Finance Study Group of the Research Institute of Economy, Trade, and Industry (RIETI). The author would like to thank RIETI for many supports. The author gratefully acknowledges the financial support of a Grant-in-Aid for Young Scientists (B) from the Japan Society for the Promotion of Science. The author would also like to thank the editor (Mark P. Taylor) and two anonymous referees for their many valuable comments. Thanks also to Hidehiko Ichimura, Ryoji Takehiro, Hiroshi Uchida, Iichiro Uesugi, Tsutomu Watanabe and Peng Xu, seminar participants at RIETI and Hosei University and attendees at the Japanese Economic Association (JEA) Annual Meeting held at Tohoku University for their useful suggestions. All errors remain the responsibility of the author.

Notes

1  See Hoshi and Kashyap (2004) for a discussion of the recession in Japan from 1990 to 2003. The sample period in our analysis covers the final period of Japan's ‘Lost Decade’.

2  The results in Summers and Wilson (2003) also indicate that firms offer more credit to customers with a stronger bargaining position.

3  Molina and Preve (2012) focus on the effects of financial distress on trade payables and find that financially distressed firms increase the amount of trade payables to compensate for the reduction in alternative sources of finance.

4  Large firms represent about 10% of the combined firm sample, with the remainder being SMEs.

5  We do not use the cash–total assets ratio in the regression for the level of trade receivables because of the need to consider serious simultaneity bias.

6  These are the trade receivables–sales ratio, interest rates, ROA, annual changes in the trade receivables–sales ratio, interest rates and ROA, sales growth and leverage.

7  As in Uchida et al. (2013), we also estimate the effects of the length of the relationship with the main customer as a proxy for the customer relationship. These effects are not statistically significant, suggesting that the length of the customer–supplier relationship exerts little effect on the provision of trade credit.

8  We checked the structural stability of our results for customer relationships using the Chow test. We divide our sample by year and test the null hypothesis that in Equation 1. In all equations, the null hypothesis is accepted, suggesting that our estimated results for customer relationships satisfy structural stability.

9  In addition, there may be over-bias in the trade receivables–sales ratio for firms experiencing a decline in sales because of a lag between the decrease in trade receivables and the decrease in sales.

10  As for the results in Table 4, the length of the customer–supplier relationship has little effect on the annual change in the provision of trade credit. In addition, similar to the point in footnote 8, our estimated results for customer relationships satisfy structural stability.