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An Agency Model for Trade Credit Policy

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Abstract

This article proposes an agency model to explain the trade credit offer to clients. Our model is based on the existence of asymmetric information between sellers and buyers, which results in the appearance of two phenomena known as adverse selection and moral hazard. The former has already been explored by other authors, but not the latter, i.e., the possibility of the buyer not paying the provider. The results obtained indicate that days of sales outstanding of firms are positively related to adverse selection and negatively related to moral hazard. In order to test the moral hazard hypothesis, we use three variables: variable cost, demand elasticity and bad debts. Variable cost and demand elasticity present the expected relation, but bad debts only presents the negative expected relation at low levels, which suggests that when a firm presents high levels of bad debts the risk of the portfolio of clients is also high. In this case, the clients are more likely to present a low liquidity situation and consequently do not take advantage of the use of cash discounts. Traditional models are also tested and compared with the proposed model. We did not find evidence to support tax theory or to support the operational argument of transaction cost theory. We find weak evidence to support the liquidity theory, while the asymmetric information theory was confirmed. A comparison between the agency model proposed and traditional models concluded that the Agency model reached better results in the explanation of the subject of study.

Suggested Citation

  • Bastos, Rafael & Pindado, Julio, 2005. "An Agency Model for Trade Credit Policy," Working Papers "New Trends on Business Administration". Documentos de Trabajo "Nuevas Tendencias en Dirección de Empresas". 2005-03, Interuniversity Research Master and Doctorate Program (with a quality mention of ANECA) on "Business Economics", Universities of Valladolid, Burgos, Salamanca and León (Spain). Until 2008, Interuniversity Doctorate Program (with a quality mention of ANECA) “New trends in Business Administration”, Universities of Valladolid, Burgos, and Salamanca (Spain). Master en Investigación y Programa de Docto.
  • Handle: RePEc:ntd:wpaper:2005-03
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    Cited by:

    1. 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.
    2. Galya Taseva, 2012. "Overdue Intercorporate Debts in Bulgaria," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 3, pages 76-94.

    More about this item

    Keywords

    Trade Credit; Asymmetric Information; Adverse Selection; Moral Hazard;

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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