(World Bank)
A new working paper by Leora Klapper, Luc Laeven and Raghuram Rajan shows how suppliers and buyers use trade credit as a competitive gesture and risk-management tool. The authors draw on data from nearly 30,000 supplier contracts for 56 large buyers and more than 24,000 suppliers in Europe and North America, all of varying size, investment grade and sector.
The evidence points to four important — and not mutually exclusive — ways trade credit helps to manage risk: as a method of financing, as a means of price discrimination, as a bond assuring buyers of product quality, and as a screening mechanism to gauge buyer default risk.
In particular, the largest and most creditworthy buyers receive contracts with the longest maturities (as measured by net days) from smaller, investment-grade suppliers. By contrast, early-payment discounts seem to be used as a risk management tool to limit the potential nonpayment risk of trade credit. Early payment discounts are generally offered to smaller, non-investment grade buyers. The results suggest that contract terms are jointly determined by supplier and buyer characteristics.
Download the World Bank Policy Research Working Paper 5328 here.
