Interest Rates in Trade Credit Markets

There is evidence that suppliers have private information about their customers’ credit risk. Yet, interest rates in trade credit markets are usually industry-not-firm specific. Why? If the demand for intermediate products is inelastic, suppliers should raise interest rates until they reach their customers’ outside option. By definition, this outside option cannot reflect information that is privy to suppliers. In contrast, a highly elastic demand may induce suppliers to extend credit to their customers at zero interest, making the suppliers’ private information once more irrelevant. By characterizing these two equilibria, we obtain implications on when trade credit rates shouldn’t vary with private information held by suppliers. JEL: G30, G32