Trade Credit Management and Information Asymmetry in Small and Medium-Sized Businesses in an Emerging Market.
| Autor | Mendes-Da-Silva, Wesley |
1 Motivation
Among the most relevant financial decisions taken by smaller businesses, working capital certainly constitutes a special segment, especially the role played by trade credit (Emery, 1984; Bastos & Pindado, 2013). The establishment of credit terms is a field for decisions that have great potential for influencing the firm's competition strategy, which has an impact on the firm's performance, whether as a buyer or seller (Yazdanfar & Ohman, 2016). In turn, financial decisions are predominantly taken within the context of risk, uncertainty, or even ignorance, i.e. when no relevant information content is known (Goncalves et al., 2018). Imperfect information induces uncertainty in contractual relationships, which can cause problems of a moral hazard nature, thus increasing transaction costs for the parties involved (Fabbri & Klapper, 2016).
In this paper, we examine trade credit conditions through their role of reducing information asymmetry and uncertainty for sellers and buyers in an emerging market context, which is typically characterized by information asymmetry and uncertainties in the business environment, especially for small and medium-sized enterprises (SMEs), which are the focus of this research. Specifically, we examine three main research questions: first, with regard to uncertainty for the buyer (Lee & Stowe, 1993; Long et al., 1993; Smith, 1987), based on information asymmetry and trade credit policy; second, with regard to uncertainty for the seller (Smith, 1987; Ng et al., 1999), based on information asymmetry and trade credit policy; and third, with regard to price discrimination and trade credit policy (Dana, 1998; Levine, 2002; Petersen & Rajan, 1997).
This topic is of interest not only to researchers, but also to regulators and entrepreneurs. According to Petersen and Rajan (1994), these issues are relevant for SMEs. This group of companies has a high failure rate, mainly because of their reduced ability to manage working capital (Khoo & Cheung, 2022; Murro & Peruzzi, 2022). SMEs in Brazil are also responsible for a significant portion of the employment generated, by way of which they explicitly contribute to Brazilian gross domestic product. Consultancy companies that specialize in credit in the Brazilian market, however, point out that in April 2016, of the almost 8 million companies operating in the Brazilian market, 4.4 million of them were in default, accounting for a total of more than R$ 105 billion (~US$ 40bi), with commercial companies (45.2%) and service companies (45%) predominating, according to Serasa Experian (2016). Furthermore, Fisman and Love (2003) stress the economic importance of trade credit as a source of short-term financing, especially in developing countries.
Using cross-sectional pooled OLS and logit regressions, with data collected in a survey conducted with more than 300 CFOs of SMEs operating in Brazil, we regress credit risk control and the profile of the finance manager against the average receipt period, overdue days, cash before delivery, cash on delivery, and actual cost of trade credit offered to the firm's customers and control variables for the firm's profile.
We offer two main results. First, the results point to evidence of a considerable variation in policies and practices, and to the fact that part of the variation can be explained in terms of the characteristics of the firm. Second, support is also identified for a series of hypotheses based on arguments about ways of resolving information asymmetry between buyers and sellers, as well as price discrimination.
We make several contributions to the literature, but at least two can be highlighted. First, since the literature regarding trade credit is concentrated in mature markets and listed companies (Wilson & Summers, 2002), we contribute to the trade credit literature by providing new empirical evidence about small and medium-sized businesses. Second, we do this against a backdrop of information asymmetry in a relevant emerging market context, which at least from our point of view seems to be something that has not yet been documented in the literature, which is mostly characterized by empirical evidence from mature markets.
2 Theoretical platform and development of hypotheses
2.1 Information asymmetry and trade credit policy
The theoretical line tested empirically in this article focuses on the information asymmetry between selling companies and their buying customers. Uncertainties about product quality (Akerlof, 1970) and with regard to payment due from the buyer (Paul & Boden, 2008) constitute a fertile field for explicitly relevant research in the finance area, especially when dealing with trade credit policy. The latter is a subject on which the financial community has concentrated its theoretical and empirical efforts in recent decades (Barrot, 2016; Breza & Liberman, 2017; Ewert, 1968; Herbst, 1974; Junk, 1962; Keehn, 1974; Lamminmaki & Guilding, 2004; Mian & Smith, 1992; Pike et al., 2005; Smith, 1987).
A range of theories has also been explored that look at the practice of trade credit (Biais & Gollier, 1997; Cowton & San-Jose, 2017; Ferris, 1981; Lee & Stowe, 1993; Long et al., 1993; Norrbin & Reffett, 1995; Petersen & Rajan, 1994; Schwartz, 1974; Smith, 1987; Wilner, 2000). There is little evidence, however, of the motivations behind why credit terms are modified and extended, especially when it comes to small and medium-sized enterprises (Barrot, 2016; Breza & Liberman, 2017; Petersen & Rajan, 1997). Paul and Boden (2008) point out ways in which the research could advance to understand this phenomenon better. With regard to information asymmetry and trade credit policy, this study addresses six hypotheses about uncertainties on both the buyer (Lee & Stowe, 1993; Long et al., 1993; Ng et al., 1999) and seller sides (Ng et al., 1999; Petersen & Rajan, 1997):
i) Solving uncertainties for the buyer
[H.sub.1]: Companies that sell high quality, technology-based products give longer credit periods to allow the quality of the products to be checked before any actual payment is made.
[H.sub.2]: Selling companies with less reputation give longer credit periods, when reputation is measured by way of metrics involving customer size and concentration.
[H.sub.13: Selling companies that have a high proportion of their external sales on credit give longer credit periods.
[H.sub.14: Selling companies that operate in highly seasonal markets give longer credit periods.
(ii) Solving uncertainties for the seller
[H.sub.5]: Using cash-on-delivery (CoD) or cash-before-delivery (CbD) payment conditions is more common when the seller: (a) is smaller; (b) sells mainly to end users; and (c) has a larger proportion of foreign sales on credit.
[H.sub.6]: The use of two instalment terms is associated with: (a) fewer days' delay; and (b) selling mainly to smaller customers.
Over and above discussing asymmetric information issues, there are possibilities for understanding trade credit policies better by way of price discrimination for the buyer. Negotiation between companies and their consumers, interference by the regulatory agent in regulated industries, or even the power of monopolies or oligopolies, have been covered in the literature. It is understood that concerning SMEs, the predominant view is that price formation is essentially the result of negotiation between the company and its customers. To stimulate sales, but at the same time protect itself against the risk of default, the firm establishes its credit terms, as discussed by Levine (2002) and Pike et al. (2005). Regarding price discrimination and trade credit policy, therefore, the following hypotheses are tested:
[H.sub.7a]: The actual rate of interest on immediate payment discounts is positively associated with:
i) the size of the selling company;
ii) being one of the main players in the market;
iii) adopting sales maximization (instead of risk reduction) as the main objective of credit;
iv) customer concentration;
v) negotiations with large customers;
vi) negotiations mainly with wholesale buyers.
[H.sub.7b]: The actual interest rate on immediate payment discounts is negatively associated with:
i) negotiations, mainly with the end user;
ii) the proportion of foreign sales on credit.
2.2 Trade credit in emerging economies
The literature on trade credit in emerging countries needs further investigation because the studies that are available, or that are supported by primary data (Sheng et al., 2013), have a relatively small number of either responses or variables (Carvalho & Schiozer, 2015). In this regard it might even seem surprising that subjects such as trade credit that are relatively well consolidated in the most prestigious finance textbooks require research efforts with a view to understanding the topic of working capital management better. It does not seem absurd, for example, to assume that early payments imply that discounts are offered, given the value of money over time, particularly when it comes to countries where interest rates are relatively high, as is the case with Brazil. It seems there is a lack of understanding of the topic of trade credit, which is illustrated by the fact that a specific law was passed in Brazil in 2016 authorizing the offer of discounts to those clients who wish to pay early.
3 Method
Even though the finance literature on small and medium-sized businesses may be relevant, they have not been as widely studied as they should be, given their particular relevance to emerging economies (Hermes et al., 2007; Lazaridis, 2004; Mendes-Da-Silva & Saito, 2014). One of the difficulties most indicated when it comes to carrying out studies in finance that focus on smaller businesses is access to information about these companies. The literature also points out that studies that use surveys contribute to the development of knowledge in finance in that they offer the possibility of obtaining data that are...
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