New ISAE Questions on Trade credit
by Marco Malgarini
ISAE, Rome
OECD Workshop on Business and
Consumer Tendency Surveys
Rome, September 19th 2006
New ISAE Questions on trade credit
• Starting from the first quarter of this year, ISAE has inserted in its
manufacturing survey two new questions on trade credit,
administrated in April, July, October and January, with reference,
respectively, to the first, second, third and fourth quarter of the year.
– In the last quarter, days of trade credit allowed to the clients have:
• Increased
• Stayed the same
• Decreased
– In the last quarter, days of trade credit obtained from the suppliers have:
• Increased
• Stayed the same
• Decreased
Definition of trade credit
• A simple definition of trade credit is available on Wikipedia, the publicdomain encyclopaedia on the web:
– “Trade credit exists when one provides goods or services to a customer
with an agreement to bill them later, or receive a shipment or service from a
supplier under an agreement to pay them later”.
• Trade credit may be supplied:
– in net terms, in case the payment is the same as for the “cash” payment
– On a two part terms basis, if the cash payment is given a discount
• According to some estimates, at the end of the nineties in Italy trade
credit amounted to some 500 billions euro, some 10% more than the
traditional short term bank credit (Cannari, Chiri e Omiccioli, 2005).
The economics of trade credit
• Two main explanations have been advanced in the
literature to explain the supply and demand of trade credit:
– “Real” motivations
– Financial and transactional motivations
• Real explanations of trade credit:
– TC is seen as a way for the firm to strengthen the relationship with
its clients, in case there is asymmetric information between the
seller and the buyer
– It can be expected to vary over time, possibly showing a countercyclical behavior, the firms using more trade credit to stimulate
weak demand.
Real Explanations of trade credit
• More specifically, TC may be considered as a method:
– To warrant product quality:
• payment is due only after the shipment, once the client has been able to
evaluate the characteristic of the product
• Supply of trade credit will be negatively correlated with the firm
reputation and positively with the quality of the product and the difficulty
in its evaluation;
• It will be particularly used:
– by new or small firms
– when the quality of the product is particularly important or difficult to
estimate
– when the relationship with the client is unstable
– As an insurance against high demand variability:
• It will be supplied in case of weak demand, in order to stimulate
inventory accumulation.
• It will be counter-cyclical
• It will be higher in sectors where demand is more volatile and in which
there are high stocking costs (Emery, 1997).
Financial explanations of trade credit
• With financial markets imperfections, the
financial structure is not neutral for the firm as
postulated in the Modigliani-Miller theorem.
• Use of trade credit may be determined by:
– fiscal distortions
– asymmetric information
– agency costs
• In these cases, trade credit may vary not only
across industries, but also over time, according
to financial market conditions and tax policies
Financial explanations of trade credit
• Fiscal effect: if clients have a lower fiscal rate they would
show a preference towards trade credit; on the other
hand, supply of trade credit will be positively correlated
with the fiscal rate of the supplier (Brick and Fung, 1984).
• Asymmetric information and agency costs:
– trade credit is supplied if (Schwartz (1974)), the interest rate paid
by the supplier is lower than that of the (credit rationed) client
– Similarly, trade credit may be seen as a “last resort” for firms that
have not been able to obtain short term credit on the financial
markets (Jaffe and Stiglitz, 1990).
• In this cases trade credit supplier is able to better
evaluate (with respect to financial institutions) the client
accountability, and has also stronger enforcement powers
towards him.
Transaction explanations of trade credit
o According to this explanation, firms demand trade credit
in order to:
o optimize cash flows and obtain a better synchronization between
turnover and payments (Schwartz, 1974).
o reduce money demand for transactions and precautionary motives
(Ferris, 1981).
o In both cases, trade credit will show
o positive correlation with firm specific characteristic (e.g. cash flow
variability, uncertainty)
o wide intra-industry variability
o inter-temporal stability.
Trade credit and the business cycle
• According to transactions explanations TC is
expected to vary across industries, but to be
stable over time
• According to “real” and financial explanations,
TC will vary also over time.
• Cannari, Chiri and Omiccioli (2005) find that TC
shows a negative correlation with business cycle
• Moreover, according to the financial explanation,
trade credit may also influence the transmission
mechanism of a monetary policy impulse
Trade credit and the business cycle
• A tightening of monetary policy reduces financial resources available
to firms, inducing them to cut back investment (especially liquid
inventories)
• Impact of monetary policy may be less strong if trade credit is
available: instead of cutting inventory, firms may
– raise trade credit demanded (i. e. asking for further and longer
payment delay), or
– supply less credit to their clients
• In this sense, TC may be seen as a substitute to bank credit,
especially for small firms or in general for firms having difficulties in
resorting to more traditional forms of short term debt (Meltzer, 1960).
First results
Credit from suppliers
100
I trim
IItrim
90
80
70
60
50
40
30
20
10
0
Increase
Stable
Decrease
First results
Credit from suppliers
100
I trim
IItrim
90
80
70
60
50
40
30
20
10
0
Increase
Stable
Decrease
First results
Credit supplied to clients by size of the firm
90
I trim
II trim
80
70
60
50
40
30
20
10
0
Increase
Stable
Small
Decrease
Increase
Stable
Medium
Decrease
Increase
Stable
Large
Decrease
Further research
• Results provided are derived from a very limited
data-base
• In the future it is possible to exploit the potential
information content of the ISAE survey,
considering other firm-specific data beside those
on trade credit:
– structural data on the size, industry and region of
residence of the firms,
– cyclical figures on the current and future state of
demand, production, liquidity and inventories
Trade credit supplied and demand, by
industry
35
30
25
Credit supplied
20
15
10
5
0
-40
-20
0
20
-5
-10
Demand
40
60
80
Trade credit obtained and production
expectations, by industry
20
15
10
Credit obtained
5
0
0
10
20
30
40
-5
-10
-15
-20
-25
Production expectations
50
60
70
Trade credit obtained and inventories, by
industry
20
15
10
Credit obtained
5
0
-10
0
-5
5
-5
-10
-15
-20
-25
Inventories
10
15
20
Trade credit supplied and liquidity, by
industry
35
30
25
Credit supplied
20
15
10
5
0
0
10
20
30
40
-5
-10
Liquidity
50
60
70