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Determinants of the Use of Trade Credit Discounts by Small Firms

This paper investigates the usage of Trade Credit Discounts by small firms, and examines the determinants of the buyer's decision to accept or reject discounts that have been offered by the seller as part of their trade credit terms. Using the 1998 and 2003 National Survey of Small Business Finance (NSSBF) databases compiled by the Board of Directors of the Federal Reserve Bank from a survey of small U.S. firms, we select a sample of firms that use trade credit and have been offered discounts, to model the determinants of the trade credit discount decision.

We will draw upon two theories to illuminate the firm's motivation for taking or rejecting trade credit discounts, the Pecking Order Theory of capital structure defined by Myers and Majluf (1984), and the theory of Manager ­Share holder Agency conflict first described by Jensen and Meckling (1976). Both theories offer empirically testable hypothesis that relate the firm's decision to accept or reject discounts to variables describing the firm's capital structure, its ability to meet its financial obligations in a timely manner, and to proxies that are commonly used to represent agency costs.

The contributions of this paper to the empirical literature on trade credit discounts are threefold. First, this paper addresses Agency conflicts between managers and shareholders as a motivation to refuse trade credit discounts, which we believe may be a unique contribution to the literature on trade credit discounts.

Second, this paper uses the 2003 NSSBF database for empirical analysis, which is a new database that has never before been used in a study of this kind. Third, this paper offers evidence to support the Pecking Order theory implication that firms will not reject trade discounts and take expensive trade credit unless other forms of less expensive financing are un available to it, a result that supports the findings of other researchers.

Determinants of the Use of Trade Credit Discounts by Small Firms