Trade credit financing and stock price crash risk

• Date: 01 February 2018
• Author: Kangtao Ye,Ning Zhang,Sifei Li,Feng Cao
• DOI: http://doi.org/10.1111/jifm.12067
• Published date: 01 February 2018

ORIGINAL ARTICLE

Trade credit financing and stock price crash risk

Feng Cao

1

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Kangtao Ye

2

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Ning Zhang

3

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Sifei Li

4

1

College of Business Administration,

Hunan University, Changsha, China

2

School of Business, Renmin University

of China, Beijing, China

3

Queen’s School of Business, Queen’s

University, Kingston, ON, Canada

4

School of International Business,

Beijing Foreign Studies University,

Beijing, China

Correspondence

Kangtao Ye, Renmin University of China,

Beijing, China.

Email: yekangtao@rbs.ruc.edu.cn

Funding information

National Natural Science Foundation of

China, Grant/Award Number: 71072145,

71432008, 71602053; China Ministry of

Finance, Grant/Award Number:

2015KJA009; China Postdoctoral Science

Foundation, Grant/Award Number:

2016M602413; Fundamental Research

Funds for the Central Universities, Grant/

Award Number: 531107050817

Abstract

This study investigates the association between trade

credit financing and stock price crash risk within China’s

context. We find that firms using more trade credit

financing have significantly lower future stock price crash

risk. This negative association is more pronounced for

firms with greater information asymmetry and for firms

located in less developed financial markets. This finding

is robust to the endogeneity concern, alternative measures

of stock price crash risk, and the inclusion of other fac-

tors identified in prior studies that might affect stock

price crash risk. Further evidence suggests that both the

monitoring mechanism and the disclosure mechanism

drive the documented relation. Our study suggests that

access to trade credit can significantly reduce the likeli-

hood of crash risk in a country like China with less

developed formal bank financing. Our study also suggests

that investors can effectively avoid stock price crash risk

by using the trade credit information disclosed in finan-

cial statements.

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INTRODUCTION

We examine the effect of a firm’s trade credit financing on the likelihood of future stock price

crash. Information asymmetry between corporate insiders and outsiders creates incentives for man-

agers to opportunistically withhold bad news. This information hoarding can take place either

through untimely and opaque information disclosure (e.g., Hutton, Marcus, & Tehranian, 2009;

Kothari, Shu, & Wysocki, 2009) or through real investment decisions (Bleck & Liu, 2007). At a

point when managers cannot further hoard bad news and all previously accumulated bad news is

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DOI: 10.1111/jifm.12067

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wileyonlinelibrary.com/journal/jifm J Int Financ Manage Account. 2018;29:30–56.

released at once, the stock price drops substantially and a price crash subsequently occurs (Jin &

Myers, 2006).

While existing studies have substantially examined the effect of information opacity, corporate

governance, and operating activities on stock price crash risk (e.g., Kim, Li, & Zhang, 2011a,b;

Kim & Zhang, 2014b), very few studies approach this issue from the perspective of a firm’s

financing policy. As firms’information disclosure is significantly shaped by their financing pat-

terns (Healy & Palepu, 2001), an investigation of the relationship between firms’financing policy

and stock price crash risk can provide a more complete understanding of the causes of crash risk.

In this study, we attempt to fill this void by adopting the financing perspective and investigating

how firms’financing policy affects stock price crash risk. In particular, we focus on one type of

financing instrument—that is, the use of trade credit financing.

Trade credit financing refers to the practice of customers financing their operations by delaying

payment to suppliers. Trade credit is widely used as an important instrument for short-term financ-

ing around the world. Trade credit constitutes 13% of total liabilities for the US manufacturing

companies.

1

In countries where the financial market is less developed, trade credit serves an even

more important role (Fisman & Love, 2003). For example, using an international sample,

Demirg€

ucß-Kunt and Maksimovic (2001) show that implicit financing through trade credit provides

the second most important source of external finance, next only to bank credit.

We conjecture that trade cre dit financing is negatively a ssociated with future stoc k price

crash risk, due to both the monitoring effect and the disclosure effect. First, suppliers lending

trade credit to the buyer have strong incentives to constrain the buyer’s opportunistic behavior

(e.g., investing on value-destroying projects). A reduction in managerial opportunism will trans-

late into a lower stock price crash risk (Jiang & Xu, 2015; Kim et al., 2011a,b; Xu, Li, Yuan,

& Chan, 2014). Second, the firms which rely more on trade credit financing are typically more

financially constrained (Petersen & Rajan, 1997). Hence, those firms are incentivized to improve

information disclosure so as to gain better access to external finance. The reduction in informa-

tion asymmetry would also tra nslate into a lower likelihood o f stock price crash (Hutton et al.,

2009).

We choose China as the setting to conduct this study for several reasons. Firstly, as docu-

mented in Fisman and Love (2003), trade credit is a very important financing channel in countries

with less developed financial markets. Over the past two decades, China has maintained an aver-

age gross domestic product growth rate of 8% and has become the second largest economy next

to the United States. Despite its fast growth in aggregate economic output, legal and regulatory

institutions that protect creditors and shareholders are fairly weak. Compared with develope d

countries, the Chinese economy is supported by less developed banking infrastructure and equit y

markets. Firms are more reliant on alternative financing, for example, through the supply chain,

that is, via trade credit to obtain capital (Wu, Rui, & Wu, 2012). Thus, China provides an ideal

and representative setting in which to study the impact of trade credit financing. Secondly, with

poor information disclosure and weak investor protection (Piotroski & Wong, 2010), Chinese

listed firms are subject to high risk of stock price crash (Hutton et al., 2009; Jin & Myers, 2006).

Investors and other stakeholders have a greater demand for indicators that can predict a firm’s

future crash risk.

Using a sample of Chinese listed firms covering the period from 2001 to 2012, we employ

three measures of trade credit financing: the sum of accounts payable and commercia l notes pay-

able scaled by total assets, the sum of accounts payable and commercial notes payable scaled by

cost of goods sold, and the net of total payables and total receivables. We find that all three

measures of trade credit financing are negatively associated with proxies of future stock price

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