Cost pressure, cash cycle, and trade credit

Prior research shows that firms respond to cost pressures by absorbing the costs or passing them through to customers. I show that firms can also respond by managing their cash conversion cycle through adjusting trade credit policies. Longer payment terms are a form of financing subsidy such that firms can recapture the subsidy by adjusting collection from customers and payment to suppliers. I document that cost pressure is associated with shorter cash conversion period, primarily driven by increasing accounts payable days. The results generally do not vary depending on firms’ choice to absorb costs or pass them through to customers.