Operations Dept. Seminar
Trade versus bank credit and supplier competition
Speaker(s): Prof. Jiri Chod, Boston College
Date & Time: Friday, April 22, 2016 from 10:30 a.m. to Noon
This paper examines how product market competition affects firms’ willingness to offer trade credit. We consider N suppliers who sell differentiated products through M financially constrained retailers. The retailers are exposed to exogenous demand shock and use a combination of bank and trade credit financing. The rationale for using two sources of financing is to split the default risk between the suppliers and the bank, all of whom are averse to uncertainty. Providing trade credit to a retailer frees up some of the retailer’s liquidity, which allows him to increase purchases not only from the supplier who provided this credit but also from other suppliers. This leads to a free-riding problem that is particularly detrimental when suppliers offer substitutable products and, therefore, compete not only for the retailers’ cash but also for end consumers. Thus, our model predicts a negative relationship between the prevalence of trade credit financing and competition in the upstream industry whether it is measured by the number of suppliers or the degree of competitive interaction among them. We find both of these predictions to be supported by data.
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