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Trade Credit and Informational Asymmetry

Authors

  • JANET KIHOLM SMITH

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    • Department of Economics, Arizona State University. I would like to thank Tim Campbell, Andrew Christie, Kim Dietrich, Roger Faith, Steve Ferris, Larry Harris, Ben Klein, Alan Shapiro, Richard Smith, Mark Weinstein, and Fred Weston for comments on earlier drafts. I also benefited from discussion by participants of the Sloan Workshop, UCLA, and from comments of an anonymous referee. Financial support was provided by the Center for Financial System Research. A.S.U.

ABSTRACT

Commonly used trade credit terms implicitly define a high interest rate that operates as an efficient screening device where information about buyer default risk is asymmetrically held. By offering trade credit, a seller can identify prospective defaults more quickly than if financial institutions were the sole providers of short-term financing. The information is valuable in cases where the seller has made nonsalvageable investments in buyers since it enables the seller to take actions to protect such investments.

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