Cheap Trade Credit and Competition in Downstream Markets
Antitrust authorities and scholars in industrial organization should start to consider trade credit besides prices in their decisions. That is the recommendation by Professor Mariassunta Giannetti in the paper “Cheap Trade Credit and Competition in Downstream Markets”, recently accepted for publication in the Journal of Political Economy.
Trade credit is by far the most important source of short-term funding for firms. Huge and tiny firms fund themselves with trade credit, and extend trade credit to their customers. Largely for lack of good data sources, trade credit is understudied.
The research team consisting of; Mariassunta Giannetti, Stockholm School of Economics and Swedish House of Finance; Nicolas Andre Benigno Serrano-Velarde, Bocconi University; and Emanuele Tarantino, Mannheim University provide evidence that suppliers offer cheap trade credit to ease competition in downstream markets. Suppliers that have to transfer surplus to high-bargaining-power customers would want to offer an increasing price schedule to preserve sales to other buyers. Suppliers can implement this by choosing a trade credit limit up to which customers can purchase on account. This contractual feature allows suppliers to maintain high-bargaining-power customers' marginal costs high and limits competition in the downstream market.
Empirically, Mariassunta Giannetti and her colleagues find that trade credit targets infra-marginal units and is granted when suppliers fear the cannibalization of sales to other customers. Exploiting a law that lowered the cost of offering trade credit, the researchers show that higher provision of trade credit to high-bargaining-power customers leads to an expansion of the suppliers' sales to low-bargaining-power customers.
– Offering funding to a customer is a credit decision and like any other extension of credit may reflect risk consideration. For this reason, we show that suppliers can offer a lot of cheap trade credit to some important customers and very little or no trade credit to other customers, says Mariassunta Giannetti.
A new framework for competition authorities
The paper provides a new framework for competition authorities to evaluating the effects of trade credit on competition. While it may appear to provide an unfair competitive advantage to large firms, trade credit favors relatively smaller firms and is desirable when concerns about dynamic efficiency are important. Trade credit, however, is costly in terms of static efficiency, as it favors entry by maintaining higher prices in the downstream market.
– Our paper provides a new framework for competition authorities to evaluating the effects of trade credit on competition. In a follow up we are currently exploring how trade credit helps the transmission of unconventional monetary policy in the euro area, says Mariassunta Giannetti.