Trade Credit, Markups, and Relationships

Abstract

Trade credit is the most important form of short-term finance for firms. In 2019, U.S. non-financial firms had about $4.5 trillion in trade credit outstanding equaling 21 percent of U.S. GDP. This paper documents two striking facts about trade credit use. First, firms with higher markups supply more trade credit. Second, trade credit use increases in relationship length, as firms often switch from cash in advance to trade credit but rarely away from trade credit. These two facts can be rationalized in a model where firms learn about their trading partners, sellers charge markups over production costs, and financial intermediation is costly. The model also shows that saving on financial intermediation costs provides a strong rationale for the dominance of trade credit. Using Chilean data at the firm-product-level and the trade-transaction level, we find support for all predictions of the model.