Small lending big: The real effects of trade credit demands on constrained suppliers

We examine a novel but economically important characterization of trade credit relationships in which smaller, often credit constrained, suppliers provide financing for their larger investmentgrade buyers. Using variation in large retailers’ cash management policies to instrument for how quickly individual vendors are paid, we show that firms are forced to cut back on investment in new plants and equipment when their buyers pay more slowly. By way of example, a one month delay in payment by Wal-Mart causes a 1.5% reduction in capital expenditures for the representative WalMart supplier. We find limited evidence of adjustment along financial margins. Meanwhile, the underinvestment comes at the cost of long-term profitability, with declining return on assets evident for up to 4 years. Our tests suggest this is due to suppliers facing limitations in their own ability to raise debt, in spite of the quality of receivables being funded. Using data on warranty claims, we find support for the hypothesis that uncertainty regarding product quality is an important driver of upstream financing.