Bank Loans, Trade Credits, and Borrower Characteristics: Theory and Empirical Analysis

Trade credit is a non-bank financing offered by a supplier to finance the purchase of its product. Trade credit is one of the important sources of debt financing which can substitute bank loan. Trade credit is prevailing among riskier borrowers, competing with bank loan in corporate loan market. The prevalence of trade credit implies that there exist mutual economic benefits for both suppliers and buyers from transacting trade credits even though the default rate of trade credits is much higher than that of bank loans. This paper models the economic incentive for product suppliers to offer trade credits to riskier borrowing firms which might not be able to obtain financing from conventional and specialized financial institutions such as banks. When the product market is imperfect, a product supplier can obtain additional mark-up by increasing the sale of products. That is, there is a gain to offering trade credits to facilitate the purchase of inputs to riskier borrowing firms who cannot obtain bank financing. Therefore, trade credits service riskier borrowing firms than bank loans in the corporate loan market. The empirical analyses using Compustat and LPC DealScan data supports the theoretical prediction that a riskier borrower seek for more trade credit financing, independent of bank loan access