Trade credit terms offered by small firms: survey evidence and empirical analysis

Abstract

This paper builds on work by Ng, Smith and Smith ( 1998) who attempt to explain variations in the credit terms offered by firms engaged in interfirm trade Their results suggest support for theories that explain credit terms as contractual solutions to informational problems concerning product quality and buyer credit risk This paper analyses the determinants of credit periods and credit terms amongst a sample of 500 small businesses using a unique firm-level data-base. Small businesses have been analysed in relation to their demand for trade credit (see Petersen and Rajan, 1997 and Elliehausen and Walken, 1992), payment behaviours and the determinants of accounts receivable (Petersen and Rajan, 1997) but their has been little focus on the determinants and use of credit terms by smaller businesses as suppliers of trade credit. Indeed theory suggests that firms facing a higher cost of institutional credit would be less likely to offer trade credit. Consequently it is interesting to examine the extent to which smaller firms extend credit to their customers and the motives for so doing As in g, Smith and Smith (1998) we begin by modeling the firms credit policy choices ; whether to extend credit or require cash payment; in addition we are able to model the credit period (days credit) extended under net terms using tobit and ordered probit estimation; whether the firm offers discount for prompt payment and if so the determinants of variations in two-part terms. These choices are modeled in relation to product Characteristics, demand characteristics, the nature of the customer-base, market characteristics and the firms banking relationships. The results support Ng, Smith and Smith. In addition there is much evidence that smaller firms face difficulties in enforcing credit terms in the face of incomplete contracts and asymmetric supplier-customer bargaining relationships. Their firm level choices may be constrained by their own ability to raise institutional finance We present some evidence on the marketing and strategic motivations for young and growing firms extending credit and varying their credit terms. Trade credit plays an important 'signaling' role for firms wishing to gain sales and establish reputation.