Trade credit and credit rationing

Asymmetric information between banks and firms can preclude financing of valuable projects. Trade credit can alleviate this problem by incorporating in the lending relation the private information held by suppliers about their customers. Incentive compatibility, conditions 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), without relationships with banks resort more to trade credit, and sellers with greater ability to generate cash flows Provide more trade credit. Finally small firms react to monetary contractions by using trade credit, consistent with the empirical results of Nilsen (1994).