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The product differentiation hypothesis for corporate trade credit

  • George W. Blazenko

    (Simon Fraser University, Faculty of Business Administration, Burnaby, BC, Canada)

  • Kirk Vandezande

    (Solutions by Sequence Inc., Toronto, Ontario, Canada)

Registered author(s):

    The product differentiation hypothesis for trade credit says that business managers use trade credit like advertising to differentiate their products. Prior studies of this hypothesis conclude that higher profit margins induce firms to increase trade credit and vice versa. We better represent the relation between the cost of bad debts and the price of the product offered on credit. When prices are higher, firms suffer greater losses from non-payment. Our model shows that, contrary to early versions of the product differentiation hypothesis, when managers adjust trade credit and profit margins for a perturbation in marginal cost, optimal profit margin and trade credit may move in opposite directions. A manager maintains revenue for price elastic demand by moderating the price increase, which decreases profit margin. At the same time, the manager also increases trade credit, which serves to maintain revenue by encouraging product demand. We report evidence of a negative relation between corporate receivables and profit margin. Copyright © 2003 John Wiley & Sons, Ltd.

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    File URL: http://hdl.handle.net/10.1002/mde.1113
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    Article provided by John Wiley & Sons, Ltd. in its journal Managerial and Decision Economics.

    Volume (Year): 24 (2003)
    Issue (Month): 6-7 ()
    Pages: 457-469

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    Handle: RePEc:wly:mgtdec:v:24:y:2003:i:6-7:p:457-469
    Contact details of provider: Web page: http://www3.interscience.wiley.com/cgi-bin/jhome/7976

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    1. 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.
    2. Shehzad L. Mian & Clifford W. Smith, 1994. "Extending Trade Credit And Financing Receivables," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(1), pages 75-84.
    3. Jeffrey H. Nilsen, 1999. "Trade Credit and the Bank Lending Channel," Working Papers 99.04, Swiss National Bank, Study Center Gerzensee.
    4. Ferris, J Stephen, 1981. "A Transactions Theory of Trade Credit Use," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 243-70, May.
    5. Emery, Gary W., 1987. "An Optimal Financial Response to Variable Demand," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 209-225, June.
    6. Biais, Bruno & Gollier, Christian, 1997. "Trade Credit and Credit Rationing," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 903-37.
    7. Jain, Neelam, 2001. "Monitoring costs and trade credit," The Quarterly Review of Economics and Finance, Elsevier, vol. 41(1), pages 89-110.
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