THE VALUE OF COLLATERAL IN TRADE FINANCE

Journal of Financial Economics, Forthcoming

Anna M. Costelloa

Abstract
Suppliers are subject to the credit risk of their customers when they sell products on
credit. However, rights to the collateral value of the products they sell may mitigate some
of this risk. This paper demonstrates the important role of laws that support suppliers’
rights to reclaim and liquidate collateral. Using a change in the U.S. bankruptcy code
that altered the rights of a subset of suppliers, I use a difference-in-differences setting to
show that an improvement in suppliers’ rights to the liquidation value of collateral
results in an increase in the amount and duration of trade credit offered. The increase in
collateral protection also reduced suppliers’ lending standards, resulting in more
dispersed trade credit lending and riskier customer portfolios. Finally, I find that the
increase in collateral rights decreased suppliers’ incentives to monitor their customers,
consistent with collateral and monitoring being substitutes. Overall, the paper shows
that with strong legal protections in place, trade credit has an important collateral
component.

Keywords: Trade Credit; Collateral; Lender Rights; Monitoring

JEL: D22; G30; G33

This paper was previously circulated with the title “Trade Credit Policy in Long-Term Supply
Contracts.” I thank the editor (Bill Schwert) and an anonymous referee. I also thank Jean-Noel Barrot,
John Core, Bob Gibbons, Joao Granja, Ali Hortacsu, Raffi Indjejikian, Rajkamal Iyer, Alan Jagolinzer,
Roby Lehavy, Becky Lester, Andrey Malenko, Greg Miller, Michael Minnis, Uday Rajan, Antoinette
Schoar, Nemit Shroff, Irem Tuna, Florin Vasvari, Joe Weber, Julie Wolf, Giorgio Zanarone, and seminar
participants at the George Washington Cherry Blossom Conference, London Business School, MIT
Accounting group, MIT OE lunch, Rice University, Tilburg University, University of California at Davis,
University of Colorado, University of Michigan Accounting Group, University of Michigan Hosmer-Hall,
University of Pennsylvania (Wharton), University of Washington, and Washington University for helpful
discussions and suggestions. I gratefully acknowledge financial support from the University of Michigan,
Ross School of Business. All errors are my own.
a
Corresponding Author: amcost@umich.edu. University of Michigan, Ross School of Business. 701
Tappan Ave., Ann Arbor, MI 48109

Preprint submitted to Elsevier July 10, 2018

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