Essays in Corporate Finance: The Case of Trade Credit

Abstract

Trade credit is a very important form of short term financing for US firms, constituting a significant part of capital structure. First chapter of the thesis lays a theoretical foundation to a standard assumption in the literature that trade credit is extended by the seller and seldom reversely by the buyer. Second chapter then studies the interaction between bank credit and trade credit. Using data from the financial crisis, I construct a dispersed measure of banking relationship that is orthogonal to the determinations of trade credit contracts. I find direct evidence that firms are able to substitute bank lending with trade credit when bank liquidity dries up. Firms facing less healthy banking portfolio, hence larger bank credit contraction, experienced higher growth rate in supplier credit. This rate of substitution is higher for firms with fewer outside financing options. Preliminary evidence shows that firms with higher rate of substitution recover faster from the adverse shock in financial market. This is consistent with previous findings that suppliers can act as liquidity providers to their customers when needed. Third chapter investigates the increasing reliance on trade credit of US firms over the past two decades. In conjunction with the fact that US product market has become more risky, I develop a framework with information friction and learning to explain the upward trend. With the increase in firm level risk on the product market, signals received by the banks become ever less precise. As a result, information wedge between traditional banks and suppliers widens. This leads to an increasing interval of projects that would be deemed profitable by suppliers and non-profitable by banks. As a result, customer firms obtain more credit from their suppliers for liquidity reasons and risk sharing purposes. I also provide supporting empirical evidence for the model predictions. Firms with higher firm level risk hold larger accounts payable, and industries with higher risk dispersion have higher levels of accounts payable on average. Using customer-supplier pairing data, I find heavier usage of trade credit by customers that have suppliers with lower firm level risk.