Hostname: page-component-cd9895bd7-7cvxr Total loading time: 0 Render date: 2024-12-26T08:00:53.775Z Has data issue: false hasContentIssue false
  • English
  • Français

A Pure Financial Explanation for Trade Credit

Published online by Cambridge University Press:  01 December 2009

Gary W. Emery
Get access Rights & Permissions [Opens in a new window]

Extract

This paper provided a pure financial explanation for the existence of trade credit and for the values of the credit terms offered to customers. Two motives for extending trade credit were identified. The pure operating flexibility motive arises because the opportunity to change credit policy provides the seller an efficient way to respond to fluctuations in demand. This motive was eliminated from consideration in this paper by assuming constant demand. The seller must hold a liquid reserve when the financial markets are imperfect and the desire to earn an excess rate of return on this reserve explains the pure financial intermediary motive for trade credit.

The pure financial incentive to lend this liquid reserve to customers was examined by viewing a market borrowing rate of interest that exceeds the market lending rate of interest as a hindrance to trade or, equivalently, as a financial market tariff. This tariff imposes a wedge between the market prices paid and received for the product plus a loan and thereby inflicts a loss of surplus on the seller and buyers. Trade credit lending enables the seller and/or the buyers to recapture at least part of this loss when the source of the tariff does not apply to direct loans to customers. Financial market tariffs caused by transactions costs fulfill this requirement because the trade credit lender's familiarity with its customers and product provide it with information and collection cost advantages over financial intermediaries. Tariffs caused by financial intermediary rents fulfill this requirement as well because the parties to a trade credit loan do not employ the services of a financial intermediary.

Increasing opportunity costs and financial market imperfections in addition to the ones described above establish the limits of credit policy. The optimal amount of accounts receivable is derived from the condition that the marginal revenue of trade credit lending is equal to the marginal cost. This condition combined with factoring costs produces a unique, finite optimal credit period. Accrual accounting for income tax purposes imposes an additional restriction because the firm is taxed on the recovery of its opportunity costs. These limitations on credit policy were examined separately in this paper for clarity but they are in effect simultaneously in practice.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 19 , Issue 3 , September 1984 , pp. 271 - 285
Copyright
Copyright © School of Business Administration, University of Washington 1984

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

[1]Alchian, A. “Information Costs, Pricing, and Resource Unemployment.” In Microeconomic Foundations of Employment and Inflation Theory, Phelps, Edmund S., ed. New York: W. W. Norton and Company (1970).Google Scholar
[2]Demsetz, H. “The Cost of Transacting.” Quarterly Journal of Economics, Vol. 82 (February 1968), pp. 33–53.CrossRefGoogle Scholar
[3]Hirshleifer, J.Price Theory and Applications, 2nd Edition. Englewood Cliffs, NJ: Prentice-Hall, Inc. (1980).Google Scholar
[4]Kalish, L. “The ‘Protest” in the Bank Entry Process.” Public Choice. Vol. 36 (Issue 2, 1981), pp. 287–299.Google Scholar
[5]Keynes, J.The General Theory of Employment, Interest and Money. New York: Harcourt, Brace and World (1936).Google Scholar
[6]Lewellen, W.; McConnell, J.; and Scott, J.. “Capital Market Influences on Trade Credit Policies.“ Journal of Financial Research, Vol. 1 (Fall 1980), pp. 105–113.CrossRefGoogle Scholar
[7]Peltzman, S. “Entry in Commercial Banking. “ Journal of Law and Economics, Vol. 8 (October 1965), pp. 11–50.CrossRefGoogle Scholar
[8]Pringle, J. “The Imperfect-Markets Model of Commercial Bank Financial Management.” Journal of Financial and Quantitative Analysis, Vol. 9 (January 1974), pp. 69–87.CrossRefGoogle Scholar
[9]Schwartz, R. “An Economic Model of Trade Credit.” Journal of Financial and Quantitative Analysis, Vol. 9 (September 1974), pp. 643–657.CrossRefGoogle Scholar
[10]Stigler, G. “The Economics of Information.” Journal of Political Economy, Vol. 69 (June 1961), pp. 213–225.CrossRefGoogle Scholar
[11]Stigler, G. “Imperfections in the Capital Market.” Journal of Political Economy, Vol. 75 (June 1967), pp. 287–292.CrossRefGoogle Scholar