Influence of Legal Environment and Banking System on Trade Credit in Private Firms

What is it about?

Using a firm-level database covering 52 countries during the period 2004–2021, I investigate how legal institutions and characteristics of banking systems affect the provision of trade credit for private firms. The results show that there is more reliance on trade credit versus short-term bank financing in environments characterized by higher legal enforcement while protection of creditors’ rights has no effect on the relative use of trade credit. As for the influence of the structure of the banking system, the relative use of trade credit, compared to short-term debt, increases with the weight of bank financing in the country and the existence of restrictions on banks owning and controlling nonfinancial firms. During the global financial crisis, the relative use of trade credit increased, compared to short-term debt, while it decreased during the COVID-19 pandemic.

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Photo by rupixen on Unsplash

Photo by rupixen on Unsplash

Why is it important?

Provision of trade credit in private firms is different than in public firms. Private firms, usually medium and small firms, have limited access to capital markets and theoretically tend to depend more on bank financing. Furthermore for most private firms, the relevant market for obtaining bank financing is their own country. Firms owned by a major shareholder should be reluctant to use equity financing because it could cause the controlling shareholder to risk losing control. Aditionally, private firms have less access to issue bonds since they are more opaque to investors leading to higher levels of information asymmetry between insiders and outsiders. Thus, we focus on private firms because they are more likely to face constraints on their ability to obtain external financing. Consequently, the characteristics of banking system will be more important for private firms.

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