Does trade credit really help relieving financial constraints?

• DOI: http://doi.org/10.1111/eufm.12211
• Author: Roberto Guida,Valentina Meliciani,Stefania Cosci
• Published date: 01 January 2020
• Date: 01 January 2020

DOI: 10.1111/eufm.12211

ORIGINAL ARTICLE

Does trade credit really help relieving financial

constraints?

Stefania Cosci

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Roberto Guida

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Valentina Meliciani

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1

LUMSA University of Rome, Rome,

Italy

Email: s.cosci@lumsa.it

2

International University at Rome, Rome,

Italy

Email: r.guida@unint.eu

3

LUISS University of Rome, Rome, Italy

Email: vmeliciani@luiss.it

Abstract

The European Union introduced a directive aimed at

reducing trade credit due to its supposedly negative effect

on the European economy. This contrasts with the

redistribution view arguing that trade credit could facilitate

the financing of credit-constrained firms by more liquid

suppliers. But does trade credit mainly flow from relatively

unconstrained suppliers to more financially constrained

buyers? To answer this question, we look at the character-

istics of net borrowers with respect to net lenders and then

estimate the substitutability between trade and bank debt

separately for the two groups of firms. Overall, the results

show that, in Italy, efficient redistribution does not tend to

prevail in the trade credit market.

KEYWORDS

financial constraints, redistribution view, substitutability, trade credit

JEL CLASSIFICATION

G32, G21, D82

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INTRODUCTION

The term trade credit refers to a variety of heterogeneous, unilaterally determined arrangements under

which individual suppliers of products or services allow their trade customers to defer payment for a

The authors are grateful to two anonymous referees and John Doukas (the Editor) for their helpful suggestions and

comments.

Eur Financ Manag. 2018;1–18. wileyonlinelibrary.com/journal/eufm © 2019 John Wiley & Sons, Ltd.

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198 © 2019 John Wiley & Sons, Ltd. wileyonlinelibrary.com/journal/eufm Eur Financ Manag. 2020;26:198–215.

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designated period. Most firms, in both Europe and the United States, have significant amounts invested

in accounts receivable, as well as a substantial number of accounts payable, as a source of financing.

Even if most of the economic literature emphasizes the positive role of trade credit as a means of

providing funds to credit-constrained firms, there is evidence casting some doubts on its efficient

redistribution role. Prior studies (e.g., Atanasova, 2007; Carbo-Valverde, Rodriquez-Fernandez, &

Udell, 2016; Casey & O’Toole, 2014; Emery, 1984; Ferrando & Mulier, 2013; Garcia-Appendini &

Montoriol-Garriga, 2013; Huyghebaert, 2006; Jain, 2001; Love, Preve, & Sarria-Allende, 2007;

McGuinness, Hogan, & Powell, 2018; Petersen & Rajan, 1997) support the view that trade credit

provides a useful buffer for financially constrained firms. In contrast, some recent papers (Giannetti,

Burkart, & Ellingsen, 2011; Marotta, 2005; Murfin & Njoroge, 2015; Wilson & Summers, 2002)

predict that small firms with low bargaining power sell with low margins to large customers, supply

more trade credit, and even tolerate payment delays. This paper aims to shed light on whether trade

credit is always an effective way to foster the financing of small firms and to overcome the banking

system's shortcomings or whether it is mainly the consequence of power imbalance in the supply chain

whereby more powerful players impose long payment periods on smaller enterprises.

The function of ‘intermediary of substitution’exerted by suppliers is supposedly facilitated by the

nature of the trade relation that underlies the financing. Compared to a classical financial intermediary,

intercompany relations make it possible for the seller to benefit from savings by collecting information

about firms, evaluating default risk, and evaluating products in case of bankruptcy (Petersen & Rajan,

1997). Trade credit demand is therefore justified by the need to limit the adverse effects of asymmetric

information, especially when banks do not adopt relationship lending technologies and do not produce

or use soft information about their borrowers. According to this view of trade credit (redistribution

view), firms with greater liquidity could help constrained firms finance their investment projects.

When credit flows from relatively unconstrained suppliers to more financially constrained buyers,

trade credit is characterized as an efficient financing arrangement but it is not uncommon to also

observe trade credit flowing from small, constrained suppliers to large corporations. Murfin and

Njoroge (2015) show that there are many trade credit relationships in which smaller, often credit-

constrained suppliers provide financing for their larger investment-grade buyers in the United States.

We could argue that, in this case, we have inefficient redistribution and, indeed, the European

Commission (EC) appears to be concerned with the negative consequences of late payment on the

European economy.

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According to the EC, each year, thousands of small and medium-sized enterprises

(SMEs) go bankrupt waiting for their invoices to be paid. Directive 2011/7/EU (ENTR/172/PP/2012/

FC −LOT 4) has implemented strict measures that are expected, when properly implemented by EU

countries, to contribute significantly to employment and growth and to improve the liquidity of

businesses by combating late payment in commercial transactions. The EC therefore believes there to

be issues in the conditions determined by suppliers under which they trust their customers to defer

payment.

According to EC (2015), three main factors explain the differences across countries, over time, and

across sectors regarding late payments: the prevailing business culture, deterioration of the general

economic climate, and power imbalance in the supply chain whereby more powerful actors impose

long payment periods on smaller suppliers (see also Marotta, 2005). However, the EC (2015, p. 30) also

recognizes the financing role of trade credit by stating: ‘Armed with better information and

occasionally more influence over their trading partners, suppliers can actually be more effective sub-

prime lenders than the banking sector.’

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See http://ec.europa.eu/growth/smes/support/late-payment_en

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ET AL.

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