Trade Credit Contracts, Theories and their Applications: A Synthesis of the Literature

Abstract

The paper studies theories relating to trade credit contracts as well as their applications and limitations, via review and synthesis of the trade credit literature. Using keywords and search phrases, the literature was identified from key economics, business and financedomains. Trade credit contracts are not complex, this can be explained by factors such as shortness of credit period, frequent transactions, proximity and interaction between trading parties, and effective informal enforcement mechanisms. In contrast to the longstanding conception that trade credit is more expensive than bank credit, trade credit is often cheaper than bank credit, hence its high incidence and level of use across countries. The high use of trade credit should warrant some policy attention, particularly trade credit regulation. Theories explaining trade credit are highly interconnected; most of them have received considerable empirical support in both developed and developing countries. The interconnected nature of the trade credit theories should inform methodological approaches to their empirical testing and present an opportunity for comprehensive theory development in the field. Keywords: Trade Credit, Trade Credit Contracts, Trade Credit Theories, Trade Credit Motives, Trade Credit Supply and Demand