Trade Credit, Demand Shocks, and Liquidity Management

The provision of trade credit has been explained both by theories that focus on its role in contracting for transactions between firms and by theories that focus on the advantages of liquidity provision along the supply chain. We use the 2007-2009 financial crisis and recession as a natural experiment to test trade credit theories. High-demand firms become more constrained relative to their investment needs, do not provide additional liquidity to their suppliers, and increase acquisition activities once the liquidity crunch dissipates. These firms’ accounts payable increase proportional to their raw-material inventories, consistent with the transactions-based theories. Thus, trade credit is unlikely to be effective in financing the corporate sector during crises