Interest Rates in Trade Credit Markets

All things equal, interest rates should increase with the borrower's risk. And yet, Klapper, Laeven, and Rajan (2012) cannot find such a positive relation in a broad sample of trade credit contracts. We shed some light on this puzzle by arguing that competition between informed and uninformed suppliers weakens the link between the trade credit cost and the borrower's creditworthiness. Our model implies that trade credit rates are more likely to increase with the borrower's risk if suppliers are less profitable, have high cost of funds, or sell inputs to firms plagued by moral hazard and financial distress.