Syndicate content

May 2014

Trade Credit and Organizational Form: Evidence from the Regulation of Buyer-Supplier Contracts

Andrés Liberman's picture

What makes firms decide whether to buy their inputs from another firm or to vertically integrate and become their own supplier? Contracting problems between buyers and suppliers motivate a vast literature on the boundaries of the firm (e.g., Coase 1937, Williamson 1975, Grossman and Hart 1986). In particular, firms may choose to enter into procurement contracts with suppliers or source goods internally depending on the degree to which future contingencies can be specified between the two parties (i.e., what economists refer to as “contract incompleteness”). For example, if there is no contractual way to mitigate the uncertainty about the value of an intermediate good, a buyer firm may prefer to vertically integrate and avoid having to renegotiate with the good’s supplier in the future. In this context, trade credit, or delayed payment, may play a key role in allowing suppliers to guarantee the quality of their goods, enabling market-based procurement relationships. In a new paper, Emily Breza (Columbia) and I test this claim empirically.