IDEAS home Printed from https://ideas.repec.org/p/oxf/wpaper/648.html
   My bibliography  Save this paper

Vertical Relational Contracts and Trade Credit

Author

Listed:
  • Marta Troya-Martinez

Abstract

This paper uses a vertical relational contract between two firms to explore the implications of trade credit when the ability to repay is not observed by the supplier. Trade credit limits the supplier's possibilities to punish the cashless downstream firms and termination may be used in equilibrium. We find that the supplier always sells too little despite having enough instruments to fix the double marginalization problem. The downward distortion in the quantity results from the need to make the contract self-enforced and/or to tackle the asymmetric information problem. The distortion remains even as the firms become arbitrarily patient and a larger discount factor does not necessarily translate into a larger welfare. We show that the optimal contract resembles a simple debt contract: if the fixed repayment is met, the contract continues to the next period. Otherwise, the manufacturer asks for the highest possible repayment and terminates for a number of periods. The toughness of the termination policy decreases with the repayment.

Suggested Citation

  • Marta Troya-Martinez, 2013. "Vertical Relational Contracts and Trade Credit," Economics Series Working Papers 648, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:648
    as

    Download full text from publisher

    File URL: https://ora.ox.ac.uk/objects/uuid:399735ba-b497-44d2-b67a-c381c92fdeb2
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June.
    2. Smith, Janet Kiholm, 1987. "Trade Credit and Informational Asymmetry," Journal of Finance, American Finance Association, vol. 42(4), pages 863-872, September.
    3. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(1), pages 1-41.
    4. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
    5. Peter M. DeMarzo & Michael J. Fishman, 2007. "Agency and Optimal Investment Dynamics," The Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 151-188, January.
    6. 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.
    7. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    8. William Fuchs, 2007. "Contracting with Repeated Moral Hazard and Private Evaluations," American Economic Review, American Economic Association, vol. 97(4), pages 1432-1448, September.
    9. Rocco Macchiavello & Ameet Morjaria, 2015. "The Value of Relationships: Evidence from a Supply Shock to Kenyan Rose Exports," American Economic Review, American Economic Association, vol. 105(9), pages 2911-2945, September.
    10. Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
    11. Uchida, Hirofumi & Udell, Gregory F. & Watanabe, Wako, 2013. "Are trade creditors relationship lenders?," Japan and the World Economy, Elsevier, vol. 25, pages 24-38.
    12. George Baker & Robert Gibbons & Kevin J. Murphy, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(4), pages 1125-1156.
    13. Fafchamps, Marcel, 1997. "Trade credit in Zimbabwean manufacturing," World Development, Elsevier, vol. 25(5), pages 795-815, May.
    14. Rajan, Raghuram G & Zingales, Luigi, 1995. "What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-1460, December.
    15. Mariassunta Giannetti & Mike Burkart & Tore Ellingsen, 2011. "What You Sell Is What You Lend? Explaining Trade Credit Contracts," The Review of Financial Studies, Society for Financial Studies, vol. 24(4), pages 1261-1298.
    16. Paul Povel & Michael Raith, 2004. "Optimal Debt with Unobservabable Investments," RAND Journal of Economics, The RAND Corporation, vol. 35(3), pages 599-616, Autumn.
    17. Arup Daripa & Jeffrey Nilsen, 2011. "Ensuring Sales: A Theory of Inter-firm Credit," American Economic Journal: Microeconomics, American Economic Association, vol. 3(1), pages 245-279, February.
    18. Marcel Fafchamps, 2004. "Market Institutions in Sub-Saharan Africa: Theory and Evidence," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262062364, December.
    19. Simon Johnson & John McMillan, 2002. "Courts and Relational Contracts," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 18(1), pages 221-277, April.
    20. Fafchamps, Marcel, 2000. "Ethnicity and credit in African manufacturing," Journal of Development Economics, Elsevier, vol. 61(1), pages 205-235, February.
    21. Vicente Cuñat, 2007. "Trade Credit: Suppliers as Debt Collectors and Insurance Providers," The Review of Financial Studies, Society for Financial Studies, vol. 20(2), pages 491-527.
    22. James M. Malcomson, 2012. "Relational Incentive Contracts [The Handbook of Organizational Economics]," Introductory Chapters,, Princeton University Press.
    23. Gropp, Reint & Boissay, Frédéric, 2007. "Trade credit defaults and liquidity provision by firms," Working Paper Series 753, European Central Bank.
    24. Mailath, George J. & Samuelson, Larry, 2006. "Repeated Games and Reputations: Long-Run Relationships," OUP Catalogue, Oxford University Press, number 9780195300796.
    25. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    26. Bernstein, Lisa, 1992. "Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry," The Journal of Legal Studies, University of Chicago Press, vol. 21(1), pages 115-157, January.
    27. McMillan, John & Woodruff, Christopher, 1999. "Dispute Prevention without Courts in Vietnam," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 15(3), pages 637-658, October.
    28. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 647-663.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Marta Troya-Martinez, 2017. "Self-Enforcing Trade Credit," Working Papers w0240, Center for Economic and Financial Research (CEFIR).
    2. Marta Troya-Martinez, 2017. "Self-Enforcing Trade Credit," Working Papers w0240, New Economic School (NES).
    3. Troya-Martinez, Marta, 2017. "Self-enforcing trade credit," International Journal of Industrial Organization, Elsevier, vol. 52(C), pages 333-357.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Troya-Martinez, Marta, 2017. "Self-enforcing trade credit," International Journal of Industrial Organization, Elsevier, vol. 52(C), pages 333-357.
    2. Marta Troya-Martinez, 2017. "Self-Enforcing Trade Credit," Working Papers w0240, Center for Economic and Financial Research (CEFIR).
    3. Marta Troya-Martinez, 2017. "Self-Enforcing Trade Credit," Working Papers w0240, New Economic School (NES).
    4. Dang, Viet Anh, 2010. "Optimal financial contracts with hidden effort, unobservable profits and endogenous costs of effort," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(1), pages 75-89, February.
    5. Fischer, Christian, 2020. "Optimal payment contracts in trade relationships," MPRA Paper 101956, University Library of Munich, Germany.
    6. Lang, Matthias, 2019. "Communicating subjective evaluations," Journal of Economic Theory, Elsevier, vol. 179(C), pages 163-199.
    7. W. Bentley MacLeod, 2006. "Reputations, Relationships and the Enforcement of Incomplete Contracts," CESifo Working Paper Series 1730, CESifo.
    8. Leora Klapper & Luc Laeven & Raghuram Rajan, 2012. "Trade Credit Contracts," The Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 838-867.
    9. Patrick Bolton & Ye Li & Neng Wang & Jinqiang Yang, 2020. "Dynamic Banking and the Value of Deposits," NBER Working Papers 28298, National Bureau of Economic Research, Inc.
    10. Patrick Bolton & Neng Wang & Jinqiang Yang, 2016. "Liquidity and Risk Management: Coordinating Investment and Compensation Policies," 2016 Meeting Papers 1703, Society for Economic Dynamics.
    11. Rocco Macchiavello & Ameet Morjaria, 2015. "The Value of Relationships: Evidence from a Supply Shock to Kenyan Rose Exports," American Economic Review, American Economic Association, vol. 105(9), pages 2911-2945, September.
    12. Inderst, Roman & Mueller, Holger, 2003. "Credit Risk Analysis and Security Design," CEPR Discussion Papers 3686, C.E.P.R. Discussion Papers.
    13. D'Mello, Ranjan & Toscano, Francesca, 2020. "Economic policy uncertainty and short-term financing: The case of trade credit," Journal of Corporate Finance, Elsevier, vol. 64(C).
    14. Klenio Barbosa & Humberto Moreira & Walter Novaes, 2017. "Interest Rates in Trade Credit Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(1), pages 75-113, February.
    15. Fabbri, Daniela & Klapper, Leora, 2008. "Market power and the matching of trade credit terms," Policy Research Working Paper Series 4754, The World Bank.
    16. Langberg, Nisan, 2008. "Optimal financing for growth firms," Journal of Financial Intermediation, Elsevier, vol. 17(3), pages 379-406, July.
    17. Committee, Nobel Prize, 2016. "Oliver Hart and Bengt Holmström: Contract Theory," Nobel Prize in Economics documents 2016-1, Nobel Prize Committee.
    18. Eduard Marinov, 2016. "The 2016 Nobel Prize in Economics," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 97-149.
    19. Gui, Zhengqing & von Thadden, Ernst-Ludwig & Zhao, Xiaojian, 2019. "Incentive-compatibility, limited liability and costly liquidation in financial contracting," Games and Economic Behavior, Elsevier, vol. 118(C), pages 412-433.
    20. Bertrand, Jérémie & Murro, Pierluigi, 2022. "Firm–bank “odd couples” and trade credit: Evidence from Italian small- and medium-sized enterprises," Economic Modelling, Elsevier, vol. 111(C).

    More about this item

    Keywords

    Relational contracts; trade credit; imperfect monitoring;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oxf:wpaper:648. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Anne Pouliquen (email available below). General contact details of provider: https://edirc.repec.org/data/sfeixuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.