Subsidizing Inventory: A Theory of Trade Credit and Prepayment
AbstractWe propose a simple theory of trade credit and prepayment. A downstream firm trades off inventory holding costs against lost sales. Lost final sales impose a negative externality on the upstream firm. We show that allowing the downstream firm to pay with a delay, an arrangement known as “trade credit,” is precisely the solution to the problem. Solving a reverse externality accounts for the use of prepayment for inputs, even in the absence of any risk of default by the downstream firm. We clarify previously unexplained facts including the universal presence of a zerointerest component in trade credit terms, and the non-responsiveness of interest charges to fluctuations in the bank rate as well as market demand. We explain why trade credit is short term credit and why the level of provision is negatively related to sales and profit and inventory, but positively related to the profit margin. Finally, we show that under trade credit, inventory investment is invariant to the real interest rate for a wide range of parameters, explaining the puzzle posed by Blinder and Maccini (1991). This implies that standard empirical inventory models would gain explanatory power by including the subsidy effect of accounts payable.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0522.
Date of creation: Nov 2005
Date of revision:
Contact details of provider:
Postal: Malet Street, London WC1E 7HX, UK
Phone: 44-20- 76316429
Fax: 44-20- 76316416
Web page: http://www.ems.bbk.ac.uk/
Find related papers by JEL classification:
- D2 - Microeconomics - - Production and Organizations
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
This paper has been announced in the following NEP Reports:
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Simona Mateut & Spiros Bougheas & Paul Mizen, .
"Corporate trade credit and inventories: New evidence of a tradeoff from accounts payable and receivable,"
08/09, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
- Bougheas, Spiros & Mateut, Simona & Mizen, Paul, 2009. "Corporate trade credit and inventories: New evidence of a trade-off from accounts payable and receivable," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 300-307, February.
- Galya Taseva, 2012. "Factors for Trade Debts of Firms and Possibilities of Reduction of Interfirm Indebtedness(English)," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 47-64.
- Cristina Martínez-Sola & Pedro García-Teruel & Pedro Martínez-Solano, 2014. "Trade credit and SME profitability," Small Business Economics, Springer, vol. 42(3), pages 561-577, March.
- Galya Taseva, 2012. "Overdue Intercorporate Debts in Bulgaria," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 3, pages 76-94.
- Galya Taseva, 2012. "Factors for Trade Debts of Firms and Possibilities of Reduction of Interfirm Indebtedness (Bulgarian)," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 26-46.
- Galia Taseva, 2012. "Trade Credit Terms between the Firms in Bulgaria," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 4, pages 110-136.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.