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Trade Credit, Relationship-specific Investment, and Product-market Power

Author:
Nishant Dass  Jayant Kale  Vikram Nanda  


Issue Date:
2010


Abstract(summary):

The existing literature emphasizes the financing role of trade credit (TC) i. e., the notion that financially sound firms use TC to ease the credit constraints faced by weaker trading partners. We offer an alternative, but not mutually exclusive, perspective on TC serving as a commitment device. We develop a simple model in a setting with incomplete contracts and show that TC emerges as a guarantee that induces appropriate levels of relationship-specific investments (RSI) by the upstream firm. The model predicts that the TC provided by firms increases in (i) the level of their RSI, (ii) the bargaining strength of the downstream firms and the economic importance of the vertical relationship, and (iii) the cost and difficultly of verifying RSI. Our empirical results are strongly supportive of the model's predictions. Using the firm's R&D as a proxy for RSI, we examine a large panel of publicly listed firms and find that the level of TC they provide is increasing in their R&D, in measures of the competition in the industry, and in the economic importance of the vertical relationship. TC increases with information frictions such as measures of distance to downstream firms and decreases with indicators of firm transparency such as listing on the NYSE.


Page:
48


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