An Empirical Analysis of the Effect of Financial Distress on Trade Credit

Authors


We would like to thank William G. Christie (Editor), an anonymous referee, Andres Almazan, Vipin Agrawal, Gary W. Emery, Jay Hartzell, Ross Jennings, Bob Mooradian, Bob Parrino, Ramesh Rao, Sheridan Titman, Roberto Wessels, and seminar participants at the University of Texas at Austin, IAE—Universidad Austral, the University of Texas at San Antonio, IESA, Universidad Torcuato Di Tella, the 2009 FMA meeting, and the 2010 World Finance Conference. The remaining errors are our own. This paper is derived from Lorenzo Preve's dissertation at the University of Texas at Austin, and was previously circulated under the title “Financial Distress and Trade Credit: an Empirical Analysis.”

Carlos A. Molina is a Professor at Instituto de Estudios Superiores de Administración (IESA), Caracas, Venezuela. Lorenzo A. Preve is a Professor at IAE Business School at the Universidad Austral, Buenos Aires, Argentina.

Abstract

This paper studies the use of supplier's trade credit by firms in financial distress. Trade credit represents a large portion of firms’ short-term financing and plays an important role in financial distress. We find that firms in financial distress use a significantly larger amount of trade credit to substitute for alternative sources of financing. Firms that are smaller, with less market power, and with more unique products tend to use more trade credit financing when in distress. We also find that firms that significantly increase their trade payables when in financial distress, experience an additional drop of at least 11% in sales and profitability growth over the previously documented 21% average drop for financially troubled firms.

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