Exploring the decline in trade credit investment

Abstract

Purpose The purpose of this paper is to identify three factors leading to the observed decline in trade credit offered from publicly traded firms. Design/methodology/approach The study conducts firm fixed effect regressions testing the relationship between cash flow volatility and firm investment in trade credit. The relationship is further examined with all firms separated into two groups, based on SIC codes, designating if they are in industries that traditionally offer higher amounts of trade credit. Findings The proportion of US firms that has traditionally extended the most trade credit has been decreasing over time, contributing to part of the decline in trade credit offered. Increases in cash flow volatility have also contributed to decreasing investment in trade credit. The negative relationship with cash flow volatility is greatest amongst firms that traditionally place the highest value on trade credit. Firms with access to credit, proxied by investment grade debt ratings, do not experience the same decline in trade credit offered. Practical implications Firms that value the ability to extend trade credit may maintain their level of investment in trade credit, even with increased risk of cash flow volatility, by maintaining a comparative advantage in access to credit. Originality/value This study extends prior findings by providing three previously unexplored explanations for the decline in offered trade credit seen in the USA. The changing make-up of publicly traded firms, a market-wide increase in cash flow volatility, and access to credit all play an important role in observed declines of trade credit investment.

Cash flow volatility and trade credit in Asia

“…In this important paper, the authors identify a rise in cash flow volatility over time and find this increasing volatility has a negative relationship with the level of receivables firms typically hold. Harris and Roark (2017) provide further evidence of this negative relationship when identifying reasons for declining levels of receivables in the USA. This negative relationship between cash flow volatility and trade receivables is logical when put in context with additional trade credit literature.…”

Intangible assets and trade credit policy

“…The decline in investment in trade credit over the past decades is significant and well documented (Bates et al, 2009;Harris and Roark, 2017). Figure 1 graphically shows a sharp decrease following the dot-com bubble and the Great Recession.…”

“…Over the last few decades, both the proportion of firms offering trade credit and the proportion of receivables on firms' balance sheets have declined steadily (Bates et al, 2009). The magnitude of this decline is nonnegligible: Harris and Roark (2017) find that the reallocation of funds from firms traditionally extending credit to buyers amounts to a $1.2 trillion decline from 1980 to 2000. The factors contributing to this trend include increased cash flow volatility, additional research and development (R&D) investments, as well as the evolution of the composition of listed firms (Fama and French, 2004;Bates et al, 2009;Harris and Roark, 2017).…”

Research on trade credit – a systematic review and bibliometric analysis

“…Therefore, while craving for survival, liquidity constrained firms would prefer reducing the TC period and rely on functional legal mechanisms to expedite faster recollection (Barrot, 2016). Similarly, reduction in the level of TC by firms facing cash flow volatility is a reflexive outcome (Harris and Roark, 2017) as the natural outcome of financial constraints is adverse with reduced liquidity leading to the bankruptcy of creditors. However, Breza and Liberman (2017) found that restrictions to the set of feasible financial contracts affect the buyer-supplier relationships, which in turn diminish the likelihood of a trade.…”