Trade Credit as Collateral

Abstract

A remarkable feature of short-term business finance is the widespread use of trade credit as collateral in bank borrowing, especially by small and medium-sized firms. The paper models the incentives for a firm to collateralize accounts receivable as a trade-off between the benefit from lower interest rates and the implicit cost from the disclosure of private information associated with this form of collateral. The model shows that the share of receivables pledged as collateral is larger: i) when the borrowing firm is riskier (and the difference in interest rates between secured and unsecured lending is larger); ii) when information disclosure costs for the firm are lower (e.g., when the information is dispersed among many banks and firmÂ’s assets are mostly made up of tangibles); iii) when the default correlation between sellers and buyers is lower; iv) when the legal protection of creditors is weaker (and suppliers have a stronger advantage over banks in monitoring and enforcing loan contracts). These predictions are supported by empirical evidence in a sample of 7,250 Italian firms.trade credit, collateral, information disclosure