Outside financing of firms that gave trade credit

What is it about?

We analyze corporate financing with a bank loan (or equity) when the firm gives trade credit using contract theory. There is a moral hazard, where the firm cannot be monitored and may not exert enough effort towards the project. In the symmetric case, the bank and the firm have the same information whether the trade credit will default or not. In the asymmetric case, the firm learns whether its buyer will pay or not before choosing her level of efforts.

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Why is it important?

We prove that in the asymmetric case the borrowing capacity (the available bank loans) and the welfare of the society are weakly smaller than in the symmetric case. We also show that the default risk of a given trade credit weakly decreases borrowing capacity compared to the case when the buyer pays for sure. However, it turns out that having a risky buyer might increase borrowing capacity and welfare, which can be used as a signaling device.

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