Product Quality and Payment Policy

This paper provides a theoretical explanation for the choice of payment terms under which a company sells its products. In our model, these terms are chosen to permit sellers or buyers to specialize at repairing defects if they are equally well-informed about quality or if one has significantly lower repair costs than the other. Otherwise, the terms are chosen to signal product quality. We also develop the empirical implications of this theory by predicting a seller's choice of payment terms based on the characteristics of its product market.