Trade credit: the interaction of financing, marketing, operations, and risk behavior

This paper builds an inter-organizational Stackelberg game model of trade credit. The incentive-compatible decision on credit term is made endogenously and in coordination to ensure Pareto optimality for both the supplier and the retailer. Our model factors in financing, marketing, operations, default risk, and risk attitude coherently, treating trade credit as their intersectional nexus. We introduce the uncertainty due to the possible default of the retailer on the accounts payable into our model. The in-kind nature of trade credit is in line with the two-stage lottery method employed in this paper to capture the consequences of default on trade credit effectively. We find that financing capacity encourages the supplier to extend the credit term: a larger market demand rate prompts the supplier to extend a longer credit term, but a higher holding cost for the retailer shortens the length of the credit term received. More risk-averse suppliers tend to grant shorter term, but the impact of risk attitude is insignificant. Empirically, we find evidence supporting our main theoretical predictions by employing a panel sample of manufacturing companies covering 1998–2007 from the COMPUSTAT database.