Trade Credit and Industry Dynamics: Evidence from Trucking Firms

• Author: JEAN‐NOËL BARROT
• Date: 01 October 2016
• Published date: 01 October 2016
• DOI: http://doi.org/10.1111/jofi.12371

THE JOURNAL OF FINANCE •VOL. LXXI, NO. 5 •OCTOBER 2016

Trade Credit and Industry Dynamics: Evidence

from Trucking Firms

JEAN-NO ¨

EL BARROT∗

ABSTRACT

Long payment terms are a strong impediment to the entry and survival of liquidity-

constrained firms. To test this idea and its implications, I consider the effect of a

reform restricting the trade credit supply of French trucking firms. In a difference-

in-differences setting, I find that trucking firms’ corporate default probability de-

creases by 25% following the restriction. The effect is persistent, concentrated among

liquidity-constrained firms, and not offset by a decrease in profits. The restriction also

triggers an increase in the entry of small trucking firms.

NONFINANCIAL FIRMS ARE THE main providers of short-term corporate financing

to their customers. Accounts payable are three times as large as bank loans

and 15 times as large as commercial paper on the aggregate balance sheet of

nonfinancial U.S. businesses.1Moreover, interfirm lending finances a dispro-

portionate share of global trade.2Yet despite its economic significance, trade

credit supply has received little attention relative to firms’ other financial and

real activities, mainly due to the lack of an appropriate empirical setting.3In

particular, the implications of trade credit provision for firms’ corporate liquid-

ity remain poorly understood.

While financially stronger firms can extend trade credit to their customers

in the form of long payment terms, doing so might expose their financially

∗Jean-No¨

el Barrot is with MIT Sloan School of Management and CEPR. I am indebted to

Antoinette Schoar and David Thesmar for their invaluable guidance and support. I am grateful

to Michael Roberts (the Editor) as well as two anonymous referees for their suggestions. I thank

Francois Derrien, Laurent Fresard, Denis Gromb, Uli Hege, Augustin Landier, Clemens Otto,

and Mitchell Petersen for their very helpful comments in the early stages of this project. I am

deeply grateful to Claire Lelarge for her insights and assistance with the data. This work also

benefited greatly from conversations with Pol Antras, Adrien Auclert, Arnaud Costinot, and Fritz

Foley and from the suggestions of seminar participants at the University of Zurich, Wharton,

Berkeley Haas, MIT Sloan, Harvard Business School, Yale SOM, Kellogg, Chicago Booth, UNC

Kenan-Flager,Fisher College at Ohio State University, Stanford GSB, ESSEC, Cornell, Dartmouth,

Duke, Princeton, and Brigham YoungUniversity. All remaining errors are my own. I acknowledge

support from the AXA Research Fund and the HEC Paris Foundation.

1As of September 2012, according to the U.S. Flow of Funds Accounts.

2Antr`

as and Foley (2011) analyze the sales of a large U.S.-based producer of frozen and refrig-

erated food products, exporting its production to 140 countries. They find that accounts receivable

support 39.2% of total sales and 78.2% of sales to common law countries.

3Among notable exceptions are the supplier-customer data sets used in Antr`

as and Foley (2011)

or Klapper, Laeven, and Rajan (2012).

DOI: 10.1111/jofi.12371

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1976 The Journal of Finance R

weaker rivals to liquidity shocks. Depending on the intensity of competition,

the latter might not be able to pass this excess liquidity risk on to prices. Long

payment terms extended by financially stronger firms might thus prevent their

constrained rivals from entering, expanding, and surviving in the industry.

The main challenge in identifying this mechanism is that firms compete on

many dimensions, and financially stronger firms might have other comparative

advantages over their constrained competitors.

To solve this identification challenge, I exploit a large and exogenous restric-

tion on trade credit supply. In particular, I consider a trade credit regulation

reform that went into effect in 2006 and prevented French trucking firms from

extending to their customers payment terms in excess of 30 days. This resulted

in a significant 15% reduction in payment terms relative to their prereform

level. Using a unique data set covering the universe of all French firms, I

implement a difference-in-differences (DID) approach to estimate the effect of

this trade credit restriction on trucking firms’ corporate policies, entry, and

exit. To do so, I compare the performance of trucking firms to the performance

of a control group including all industries that do not use trucking services

but have similar customers and suppliers as trucking firms. In robustness

tests, I use an alternative control group constructed by matching each trucking

firm with a nontrucking firm with similar firm-level characteristics, such as

size, profitability,tangibility, leverage, and trade credit supply,and find similar

results.4

I first examine whether long payment terms impose high liquidity risk on

firms, especially financially constrained firms. A priori, there is no obvious rea-

son that this should be the case. Accounts receivable are typically taken to be

liquid assets that can be converted into cash relatively easily in the event of a

liquidity shock. In addition, financially constrained firms might extend shorter

payment terms than unconstrained firms to avoid exposure to excessive liquid-

ity risk. Instead, I find that the 4.6 percentage points decrease of the share of

accounts receivable in total assets is associated with a sizable 3.5 percentage

points increase in cash holdings. Moreover, the probability that a trucking firm

files for bankruptcy decreases by 60 bps, a 25% drop with respect to the prere-

striction level. This effect is extremely robust to alternative specifications and

control groups, shows no prior trends, and continues to hold six years after the

trade credit restriction. Furthermore, this effect is concentrated among small,

young, cash poor, highly levered, and low payout firms, which are more likely

to be liquidity constrained. Taken together, the results provide consistent evi-

dence that long payment terms impose substantial liquidity risk on financially

weaker firms, forcing them into financial distress to a greater extent than if

they were paid earlier.

I next examine whether financially weaker firms are compensated for the

liquidity risk they take by extending trade credit. It may be the case that

4Unless otherwise specified, I use the term “firms” throughout the paper to refer to trucking

and control firms that are extending trade credit and the term “customers” to refer to trucking and

control firms’ customers that are thus receiving trade credit.

Trade Credit and Industry Dynamics 1977

constrained firms charge higher prices than unconstrained firms, to cover their

higher liquidity risk. I find, however, that the decrease in corporate default

among constrained firms is not offset by a decrease in their earnings. This

result suggests that, in a competitive market where customers value trade

credit, financially constrained firms expose themselves to liquidity risk by ex-

tending trade credit that they are not able to offset with higher prices. Hence,

liquidity-constrained firms seem to be made relatively better off by the reform.

Surprisingly, the restriction of the contract set imposed by this trade credit

regulation reform thus leads to a net improvement in the risk-adjusted profits

of some market participants.

I also examine whether the liquidity risk associated with trade credit supply

acts as a barrier to entry for financially constrained entrepreneurs. Again,

there is no obvious reason why this should be the case, given that accounts

receivable are relatively liquid assets and that constrained entrepreneurs could

extend shorter payment terms to reduce liquidity risk. However, I find that

entry increases in the trucking sector following the trade credit restriction.

The increase concentrates among small businesses, shows no prior trend, and

starts to kick in one year after the reform. When I examine whether this might

be a result of low-quality entrepreneurs taking advantage of the lower working

capital requirements to enter the sector, I find instead that the productivity of

entrants is not lower after the reform. This result is consistent with the idea

that long payment terms extended by financially stronger firms raise the hurdle

for firms to enter and survive in the industry. From a broader perspective,

these results confirm that trade credit supply acts as a barrier to the entry and

survival of liquidity-constrained yet productive businesses.

The findings shed light on the implications of recent reforms undertaken

in the United States and the European Union (E.U.) aimed at accelerating

payments to small businesses. On September 14, 2011, the United States de-

ployed the QuickPay initiative, whereby all federal agencies are required to

pay their small business contractors within 15 days instead of 30 days.5On

March 16, 2013, the E.U. enacted Directive 2011/7/EU, which prevents suppli-

ers and customers from agreeing to payment terms in excess of 60 days unless

they specify otherwise in writing.6The underlying idea, which is often echoed

in the press and in business surveys both in the United States and the E.U., is

that extending trade credit is costly for small businesses. In particular, policy

makers are concerned that long payment terms may impose excess default risk

on firms.7The results in this paper show that financially constrained firms are

indeed at a comparative disadvantage in sectors with long payment terms, and

hence seem to benefit from a trade credit restriction. It is worth pointing out,

however, that, for any regulation of trade credit to be welfare-improving, there

5See http://www.whitehouse.gov/blog/2011/09/14/getting-money-small-businesses-faster.

6See Wall Street Journal, “EU targets late payers,” March 13, 2013.

7See Financial Times, “Late payments push smaller companies into bankruptcy,” March 25,

2010, Kauffman Foundation survey results summarized in Robb and Reedy (2012), or EU Com-

mission MEMO/12/742, “Let’s stop business closures caused by late payments,” October 5, 2012.