Credit Market Imperfections, Monetary Policy Shocks, and Trade Credit Durations

What is it about?

Companies typically provide distributors of their products with trade credit facilities - that is with some period of time between receipt of goods for sale and payment for goods sold. This period of time is referred to as a "trade credit duration". This study demonstrates there exists optimal lengths of time for trade credit durations. In the case of the specific firm studied, trade credit durations that are longer by about 5 weeks for every distributor would maintain sales volumes, minimize the effects of monetary policy shocks (e.g. Central Bank interventions) or imperfections within credit markets (e.g. liquidity shocks that alter structure of lending or deposit rates) on small distributors, and ensure only large monetary policy shocks or relatively severe credit market imperfections have any significant effect on large distributors.

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Why is it important?

If companies maintain trade credit durations that are too short or too long (non-optimal or sub-optimal trade credit durations), this increases the probability that small distributors will go out of business. This also increases the probability that large distributors will experience significant swings in business volumes. Since either of these two scenarios renders production planning more risky and expensive, determination and adoption of optimal lengths of time for trade credit durations will help companies improve business outcomes and minimize production or sales risk.

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