Trade Credit : Theory and Evidence for Emerging Economies and Developing Countries

Trade credit remains an important source of finance for firms in developing countries and manyfirms in developed countries, especially those that are young, small, or informationally opaque for other reasons.This paper summarizes the literature and explains the pervasiveness of trade credit, detailing its potentialadvantages over formal credit in terms of the information that buyers and sellers have about each other and theirability to monitor one another. Because it requires less formal contract enforcement, trade credit can be especiallyrelevant where the rule of law and the legal system are weak. At the same time, reliance on information from socialnetworks and informal institutional arrangements limits the scale of trade credit, and thus moderate improvements toformal enforcement can expand trade credit beyond social networks and enable customers to switch suppliers, whichimproves their credit terms. The patterns suggest a sweet spot or “Goldilocks” region where mid-size firms and thosein countries at middling levels of development tend to rely relatively more heavily on trade credit than others. Goingforward, detailed data on the relationship between suppliers and customers are crucial to enable more direct tests oftheoretical predictions regarding trade credit.