Trade credit and credit rationing

Asymmetric information between banks and firms can precludefinancing of valuable projects. Trade credit can alleviate thisproblem by incorporating the lending relation the private informationheld by suppliers about their customers. Incentive compatibilityconditions prevent collusion between two of the agents (e.g.,the buyer and the seller) against the third (e.g., the bank).Consistent with the empirical findings of Petersen and Rajan(1995), firms without relationships with banks resort more totrade credit, and sellers with greater ability to generate cashflows provide more trade credit. Finally small firms react tomonetary contractions by using trade credit, consistent withthe empirical results of Nilsen (1994).