Trade Credit, Bank Credit and Profits: Evidence from Indian Manufacturing Firms

Abstract

An important question that is empirically under researched pertains to the relationship between trade credit (accounts payable and accounts receivable), bank credit and profits when there are imperfections in the credit market. Theory predicts complementarity between accounts payable and bank credit for financially constrained firms and substitutability for financially unconstrained firms. On the other hand, only those firms that are relatively unprofitable and constrained should invest in accounts receivable. We test these predictions using a sample of 3041 Indian manufacturing firms for the period 1993 to 2009. Trade credit transactions in the Indian context are different from the developed countries as the rediscounting of such transaction bills is almost negligible in India. Using an endogenous regime switching model, we show complementarity between accounts payable and bank credit in the event of finance constraint. We also show that firms which are unconstrained or firms which are constrained and relatively profitable do not offer trade credit. In fact, firms which are constrained and unprofitable do so.