Ebook Credit Chains and Sectoral Comovement: Does the Use of Trade Credit Amplify Sectoral Shocks?
Trade credit is an important source of short-term financing for firms in the US and around the world (Petersen and Rajan, 1997; Rajan and Zingales, 1995; Demirguc-Kunt and Maksimovic, 2001). Accounts payable are more important than bank credit for short-term financing in 60 percent of the countries covered by Worldscope, and worldwide surveys conducted by the World Bank indicate that firms typically finance about twenty percent of their working capital with trade credit. In addition to extensively using trade credit as a source of funds, most firms simultaneously grant credit to their customers (McMillan and Woodruff, 1999; Fabbri and Klapper, 2008), becoming, therefore, exposed to default risk .
These characteristics of trade credit financing have led some authors to propose it as a mechanism for the propagation and amplification of idiosyncratic shocks. The intuition is straightforward: a firm facing a default by its customers may run into liquidity problems and default on its own suppliers. This sequence of defaults propagates the shock through the supply chain and may eventually amplify it, as the chain of defaults advance and the customers of the initial defaulting firm are themselves unable to pay their accounts, starting a new round of partial defaults.
Therefore, in a network where firms borrow from each other, a temporary shock to the liquidity of some firms may cause a chain reaction in which other firms also get in financial difficulties, resulting in a large and persistent decline in aggregate activity. This idea was first formalized by Kiyotaki and Moore (1997) in a partial equilibrium setting, and recently extended to a general equilibrium environment by Cardoso-Lecourtois (2004) and Boissay (2006). Beyond the transmission of shocks from customers to suppliers emphasized by these papers, trade credit may also help propagate shocks downstream if suppliers facing liquidity problems reduce their trade credit to customers (Coricelli and Masten, 2004), or, alternatively, if suppliers stop offering trade credit to customers in distress even before they actually default.
Anecdotal evidence suggests that this mechanism is likely to be relevant. Non-payment by customers is listed as a major cause of distress in several studies on the causes of bankruptcy among US firms (Bradley and Rubach, 2002; Bradley and Cowdery, 2004), and there is also widespread evidence that firms typically respond to late payment by customers by delaying payments to their trade creditors (Chittenden and Bragg, 1997; McMillan and Woodruff, 1999; Boissay and Gropp, 2007; Fabbri and Klapper, 2008).
Moreover, the role of trade credit is frequently mentioned in the business press as a source of distress propagation. For instance, a recent article in the New York Times on the consequences of bankruptcy by any of the big three US auto makers notes that a bankruptcy filing by even one of the Big Three would probably set in motion a cascade of smaller bankruptcies by suppliers of car parts, as the money the company owed them (which would be classified as an unsecured claim) could not be paid until it exited bankruptcy . Also, emphasizing the other side of transmission, the Washington Post reported that VeraSun, one of the largest ethanol producers in the US recently filed for Chapter 11 because Beginning in the third quarter, worsening capital market conditions and a tightening of trade credit resulted in severe constraints on the Company's liquidity position.
Posted in :
