Credit Contagion and Trade Credit: Evidence from Small Business Data in Japan

• Published date: 01 December 2013
• Author: Daisuke Tsuruta
• Date: 01 December 2013
• DOI: http://doi.org/10.1111/asej.12018

Credit Contagion and Trade Credit: Evidence

from Small Business Data in Japan*

Daisuke Tsuruta

Received 15 October 2011; accepted 26 April 2013

The present study investigates whether credit contagion leads to a decrease in trade

credit for small businesses. In 1997–1998, the Japanese economy experienced a

deep recession, and the domino effect caused an increase in the number of dishon-

ored bills and bankruptcy filings. During a period of credit contagion, the possi-

bility of default increases for firms with more financial claims and lower cash

holdings. We find that during a recession, trade payables for small businesses with

higher trade receivables and lower cash holdings are reduced. The hypothesis that

the effects of credit risk on trade payables are weakened is not supported.

Keywords: trade credit, contagion, financial crisis, small business.

JEL classification codes: G20, G32, G33.

doi: 10.1111/asej.12018

I. Introduction

Following the 2007 subprime crisis, many studies have analyzed the negative

effects of financial shocks. As Udell (2009) argues, the recent financial shock

could have had negative effects on the real economy, especially the small busi-

ness sector. Many studies have examined the negative shock on small business

financing through the banking sector. Small firms can have trouble accessing

capital markets because of the problem of information asymmetry between bor-

rowers and creditors. Therefore, numerous studies argue that loans from financial

intermediaries are important sources of financing for small firms. For example,

James (1987) argues that banks provide special services that are unavailable

from other creditors, while Petersen and Rajan (1994) show that lending relation-

ships with banks are valuable for borrowers wishing to mitigate problems

*College of Economics, Nihon University, 1-3-2 Misaki-cho, Chiyoda-ku, Tokyo 102-8360,

Japan. Email address: tsuruta.daisuke@nihon-u.ac.jp. The author is a researcher at the Credit Risk

Database (CRD) Association. CRD data were used with permission from the CRD Association. The

views expressed in this paper do not necessarily reflect those of the CRD Association. This study is

supported by a Grant-in-Aid for Scientific Research, Japan Society for the Promotion of Science. I

would like to thank Eric D. Ramstetter (Managing Editor) and the anonymous referee for many

valuable suggestions. I would also like to thank Fumio Akiyoshi, Masahiro Ashiya, Nobuhiro Hosoe,

Kaoru Hosono, Yoshiro Miwa, Masao Nakata, Ryosuke Okamoto, Yoshiaki Ogura, Kuniyoshi Saito,

Daisuke Shimizu, Hirofumi Uchida, Tsutomu Watanabe, Wako Watanabe and Peng Xu. The seminar

participants at the corporate finance workshop at RIETI, the JEA Annual Meeting at Osaka City

University, and the policy modeling workshop at GRIPS also provided useful comments

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Asian Economic Journal 2013, Vol. 27 No. 4, 341–367 341

© 2013 The Author

Asian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

associated with the information gap. Thus, if banks stop lending because of a

large macroshock, small firms cannot borrow enough and may, therefore, face

severe financial constraints. To maintain an adequate capital ratio after a financial

shock, as Udell (2009) argues, banks need to reduce the number of loans by

raising credit standards, making very few new loans and renewing fewer existing

loans. Consequently, small businesses may have suffered significant damage

during the financial crisis, mainly because their sources of external finance are

relatively limited.

Small businesses have other sources of financing, such as trade credit. A

financial shock can have negative effects on small businesses through trade credit

linkages. As Kiyotaki and Moore (1997, 2002) argue, nonfinancial firms form

links by providing trade credit to one another. Not only banks but also nonfinan-

cial firms provide ‘financial intermediation’ because they take credit from sup-

pliers and offer credit to their customers. If a firm experiences an unanticipated

liquidity shock and defaults, the effect of the shock spreads to the firms that have

financial claims on the defaulting firm. The effects of the unanticipated liquidity

shock spread to many other firms through a similar process. Contagion through

trade credit linkages (called credit contagion) is a serious problem for trade credit

suppliers. Raddatz (2010) shows that an increase in the use of trade credit by firms

results in an increase in their output correlation. Using a theoretical model,

Boissay (2006) shows that when customers of a healthy firm suffer financial

distress, the firm’s probability of financial difficulty increases.

In the present paper, using firm-level data, we focus on the negative effects of

financial shocks through trade credit linkages, and we investigate whether finan-

cial shocks lead to decreases in trade credit for small businesses. In particular, this

paper tests whether trade partners reduce trade credit for small firms that are

vulnerable to credit contagion. We can observe a firm’s trade payables, which are

a proxy for how much the firms borrow from their suppliers, and a firm’s trade

receivables, which are a proxy for how much firms lend to their customers. By

using balance sheet data, we can investigate the effects of financial shocks on

trade credit. According to Kiyotaki and Moore (1997, 2002), during a period of

credit contagion, the possibility of firms defaulting (especially credit-constrained

small firms) increases with the amount of financial claims against other firms. As

suppliers can observe which firms possess a large amount of trade receivables,

they will withdraw trade credit from these firms if the problem of credit contagion

becomes serious. Furthermore, firms with lower cash holdings are unlikely to

repay trade debt if credit contagion is serious, so suppliers will reduce trade credit

for these firms. In addition, if suppliers have difficulty anticipating which firms

will default because of contagion, they will withdraw credit from all their cus-

tomers, even if the firm-specific risk is low. This implies that during a financial

shock not only banks but also trade partners cut credit for small businesses,

especially those with a large amount of credit claims and lower cash holdings.

The credit chain propagation could thus cause a reduction in the provision of trade

credit.

ASIAN ECONOMIC JOURNAL 342

© 2013 The Author

Asian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd