ON THE DIMINISHING RETURN TO TRADE CREDIT

• Author: G.W. Kelly,Vinod Venkiteshwaran,Matthew D. Hill
• DOI: http://doi.org/10.1111/jfir.12061
• Date: 01 September 2015
• Published date: 01 September 2015

ON THE DIMINISHING RETURN TO TRADE CREDIT

Matthew D. Hill

Arkansas State University

G. W. Kelly

University of Southern Mississippi

Vinod Venkiteshwaran

PwC

Abstract

We examine the relation between excess returns and corporate trade credit policy.

Robust results suggest a lower market value of receivables for firms with higher lagged

receivables levels, consistent with diminishing returns from extending trade credit.

Further findings indicate that the diminishing return to trade credit varies with industry

affiliation, market share, and financial constraint. Our results emphasize the importance

of actively monitoring trade credit levels.

JEL Classification: G32, G39

I. Introduction

The management of trade credit policy is an important element of the corporate finance

function (Petersen and Rajan 1997). Using theoretical models, Kim and Atkins (1978)

and Sartoris and Hill (1981) demonstrate the potential effects of trade credit policy on

firm value. Despite these findings, only recently has the relation between shareholder

wealth and trade credit policy been examined. Hill, Kelly, and Lockhart (2012) document

a direct and significant relation between shareholder wealth and trade credit extension.

We extend the aforementioned research by examining whether the extension of

trade credit exhibits diminishing returns. This question is of interest because extending

trade credit incurs trade-offs. A primary marginal benefit of extending trade credit is

stimulation of customer demand and revenue growth (Nadiri 1969). Increased customer

demand may be attributable to trade credit alleviating customers’financial constraints, as

described by Meltzer (1960) and Schwartz (1974). Garcia-Appendini and Montoriol-

Garriga (2013) provide empirical support for this conjecture by showing that trade credit

redistributes capital from liquid firms to financially constrained customers. Trade credit

can also stimulate customer demand by reducing information asymmetries regarding

product quality. This is because trade credit periods provide the time needed to evaluate

The authors wish to thank the editors, Mark Griffiths (associate editor), and John Stowe (reviewer) for their

helpful comments that have improved the paper.

The Journal of Financial Research Vol. XXXVIII, No. 3 Pages 305–317 Fall 2015

305

© 2015 The Southern Finance Association and the Southwestern Finance Association

RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY

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