The Implicit Costs of Trade Credit Borrowing by Large Firms

We examine a novel, but economically important, characterization of trade credit relationships in which large investment-grade buyers borrow from their smaller suppliers. Using a matched sample of large retail buyers and their much smaller suppliers, we find that slower payment terms by large retailers are associated with lower investment at the supplier level. The effects are sharpest during periods of tight bank credit and for firms which we might otherwise characterize as financially constrained. The opportunity cost of extending credit to large buyers appears to be positive and sharply increasing in the financial frictions facing a firm. (JEL G20, G30, G31, G32) As of 2009, trade payables—financing for the purchase of goods extended by suppliers to their customers—represented the second largest liability on the aggregate balance sheet of nonfinancial businesses in the United States (U.S. Flow of Funds Account 2011). Yet relative to its volume as a source of corporate funding, there has been limited research on the effects of trade credit relationships on other financial and real activities of the firm. Why is so much financing in a well-developed capital market done by nonfinancial firms? The existing literature on trade credit suggests that financial constraint may play an important role, with evidence that small, young firms lean on their larger suppliers for funding when access to traditional financial markets is limited (Meltzer’s 1960; Schwartz 1974; Petersen and Rajan 1997). Yet at the same time, we also observe the inverse relationship, one which is harder to reconcile with a story based on financial constraint. Large, highly rated borrowers with unfettered access to capital markets may also borrow via trade credit, often from smaller, weaker suppliers. Walmart, for example, borrows more from its considerably smaller suppliers via trade credit than it does in bank and bond