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Ensuring Sales: A Theory of Inter-firm Credit

  • Arup Daripa
  • Jeffrey Nilsen

We propose a simple theory to account for the prevalence of interfirm credit at an interest rate of zero. A downstream firm trades off inventory holding costs against lost sales. Lost final sales impose a negative externality on the upstream firm. The solution requires a subsidy limited by the value of inputs. Allowing the downstream firm to pay with a delay is precisely such a solution. A reverse externality accounts for the use of prepayment. We clarify how input prices vary with such policies, and when trade credit/prepayment is more efficient than pure input price adjustments. (JEL D21, D62, D92, G31, L25)

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Article provided by American Economic Association in its journal American Economic Journal: Microeconomics.

Volume (Year): 3 (2011)
Issue (Month): 1 (February)
Pages: 245-79

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Handle: RePEc:aea:aejmic:v:3:y:2011:i:1:p:245-79
Note: DOI: 10.1257/mic.3.1.245
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  1. Jeffrey H. Nilsen, 1999. "Trade Credit and the Bank Lending Channel," Working Papers 99.04, Swiss National Bank, Study Center Gerzensee.
  2. 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.
  3. Petersen, Mitchell A & Rajan, Raghuram G, 1997. "Trade Credit: Theories and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 661-91.
  4. J. Stephen Ferris, 1981. "A Transactions Theory of Trade Credit Use," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 243-270.
  5. Chee K. Ng & Janet Kiholm Smith & Richard L. Smith, 1999. "Evidence on the Determinants of Credit Terms Used in Interfirm Trade," Journal of Finance, American Finance Association, vol. 54(3), pages 1109-1129, 06.
  6. Schwartz, Robert A., 1974. "An Economic Model of Trade Credit," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 9(04), pages 643-657, September.
  7. Mike Burkart & Tore Ellingsen, 2004. "In-Kind Finance: A Theory of Trade Credit," American Economic Review, American Economic Association, vol. 94(3), pages 569-590, June.
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