Emily Breza

Financial Contracting and Organizational Form: Evidence from the Regulation of Trade Credit

We present evidence that restrictions to the set of feasible financial contracts affect buyer - supplier relationships and the organizational form of the firm. We exploit a regulation that restricted the maturity of the trade credit contracts that a large retailer could sign with some of its small suppliers. Using a within-product differences-in-differences identification strategy, we find that the restriction reduces the likelihood of trade by 11 percentage points. The large retailer also responds by internalizing procurement to its own subsidiaries and reducing overall purchases. Finally, we find evidence that relational contracts can help mitigate the inability to extend long trade credit terms.We study how restrictions to the set of feasible contracts affect buyer-supplier relationships and the organizational form of the firm. We exploit a regulation change that forced a large Chilean retailer to reduce the time it took to pay some of its small suppliers, defined by an arbitrary sales cutoff, from approximately 90 to no more than 30 days. Using a within-product differences-in-differences identification strategy, we find that firms restricted in their ability to extend trade credit are 9% less likely to make a sale to the retailer and receive a 4.6% price reduction when they do make a sale. The large retailer responds by internalizing the procurement of some products previously sold by affected firms to its own subsidiaries. We interpret this as evidence that trade credit allows small firms to post a bond to guarantee product quality. When this guarantee is no longer possible, the retailer has an incentive to vertically integrate. To support this mechanism, we find evidence that the negative impacts of the regulation are mitigated for older firms, which have been able to establish a reputation, and for products with easily observable quality.