Q & A: How corporate trade credit can help fortify supply chains during disruptions

Thursday, July 16, 2020

Robert M. Townsend, together with co-authors Niklas Amberg, Tor Jacobson, and Erik von Schedvin, will publish a new paper in a forthcoming issue of Journal of Political Economy that investigates the role liquidity and trade credits can play throughout supply chains. “Curbing Shocks to Corporate Liquidity: The Role of Trade Credit” has important implications for understanding how corporations might be affected – and recover – from COVID-triggered interruptions.

Professor Townsend shares insights from the paper in this brief Q & A.

What motivates the research behind your paper, "Curbing Shocks to Corporate Liquidity: The Role of Trade Credit"?

For firms, liquidity is the key to their ability to smooth adverse shocks, such as productivity interruptions and other problems they don’t anticipate. Profitable and high-liquidity firms can avoid bankruptcy and going out of business. One might think liquidity means cash, e.g., currency or bank deposits, but in this paper, we show the concept of liquidity should be extended to include management of trade credit with input suppliers and output purchasers.

You and your co-authors find that firms manage liquidity shortages by increasing the amount of drawn credit from suppliers and decreasing the amount issued to customers.What are the primary implications of this finding for firms? The economy? Why are these implications important?

The implication for firms is that supply chains are a crucial source of liquidity, and if supply chains are disrupted, consequent liquidity shortfalls may be a source not only of short-term disruption but also can lead to business failure. When supply chains get disrupted on a larger scale, as we have seen with COVID-19, an entire economy can suffer. 

What do you see as the next questions for research on this topic? 

The primary question is to what extent has COVID19 disrupted supply chains in the US and thereby affected this key financing mechanism. Likewise, for external financial assistance programs by governments and central banks, can we target recipients better? Can we do it in such a way that injected liquidity flows upstream from sellers to input suppliers?

A second question that interests me is, given COVID19, can the role of trade credit be replaced by better financial and information infrastructure? For example, could more formal financial platforms that allow borrowing and lending among firms to improve liquidity, especially if there are provisions for business interruption insurance?

Learn more: Curbing Shocks to Corporate Liquidity: The Role of Trade Credit