In-Kind Finance: A Theory of Trade Credit

TLDR

In trade credit, opportunistic borrowers find it less profitable to divert inputs than cash, so suppliers tend to lend more liberally than banks. The authors develop a contract‑theoretic model of trade credit in competitive markets based on this argument. The model shows trade credit and bank credit can be complements or substitutes, explains the short maturity of trade credit, its greater prevalence in less developed credit markets, and the countercyclical accounts payable of large unrated firms versus small firms.

Abstract

It is typically less profitable for an opportunistic borrower to divert inputs than to divert cash. Therefore, suppliers may lend more liberally than banks. This simple argument is at the core of our contract theoretic model of trade credit in competitive markets. The model implies that trade credit and bank credit can be either complements or substitutes. Among other things, the model explains why trade credit has short maturity, why trade credit is more prevalent in less developed credit markets, and why accounts payable of large unrated firms are more countercyclical than those of small firms.