An Empirical Analysis of the Effect of Credit Rating on Trade Credit

Transcription

1 011 International Conference on Financial Management and Economics IPED vol.11 (011) (011) ICSIT Press, Singaore n Emirical nalysis of the Effect of Credit ating on Trade Credit Jian-Hsin Chou¹ Mei-Ching Yang² Tsung-Te Lin 3 ¹ Professor, Deartment of isk Management and Insurance, National Kaohsiung First University of Science and Technology, ian@nkfust.edu.tw ² Ph. D. candidate, Institute of Banking and Finance, National Kaohsiung First University of Science and Technology, u947910@nkfust.edu.tw 3 Ph. D. candidate, Institute of Banking and Finance, National Kaohsiung First University of Science and Technology, u967910@nkfust.edu.tw bstract. This study uses disaggregated anel data from Taiwan manufacturing firms and examines how firms change the trade credit in resonse to a tightening monetary olicy. The results show that both accounts receivable and accounts ayable are increased with a tightening monetary olicy, imlying that trade credit hels firms to absorb the effect of a credit condensation. dditionally, we find that the Taiwan cororate credit rating index (TCI) variable, which is the first time being used in literatures, has a strong ositive effect on the account receivable for all grous of firms, and has a strong ositive effect on the account ayable for the large firms. Keywords: trade creditightening monetary olicy, accounts receivable, accounts ayable, TCI 1. Introduction Tightening monetary olicy affects the real economy by reducing the financial resources available to enterrises. Therefore, financially constrained firms cut down on their inventory holdings. The imact of a monetary restriction, however, may be mollified the availability of trade credit (TC). Firms that an financially constrained may increase working caital by borrowing more TC (i.e. further delaying ayment of their notes). Thushe net imact of a monetary restriction deends on the use of accounts receivable and accounts ayable. Nilsen(00) shows that the ercentage is high in accounts ayable to the total liability. In articular, U.S. manufacturing firms, about 13%. This aer finds that the share of accounts ayable in the total liability is about 5% among Taiwan's firms (with the exclusion of financial industry). Such widesread trade credit warrants deely analyze both its nature and its effects on the economy. Meltzer's (I960) redistribution hyothesis resumes that large suliers ass funds via trade credit (their accounts receivable) to less liquid customers (buyers) during tight moneyhereby mitigate the effect of monetary olicy. However, emirical studies find mixed results regarding trade credit increases during monetary contractions (see. e.g., amey (199), Gertler and Gilchrist (1993) and Nilsen (00)). Using semi-aggregated data, Nilsen (00) finds that both small and large firms use more accounts ayable during monetary contractions. Choi (005) find that both accounts ayable and accounts receivable increase with tighter monetary olicy, imlying that trade credit hels firms to absorb the effect of a credit contraction. Furtherhe smaller firms increase net trade credit (accounts receivable minus ayable), making u for the reduced liquidity associated with tighter olicy. Howeverhey find no evidence that large firms lay this role more actively than smaller firms. TCI (Taiwan Cororate Credit isk Index) is a cororate credit rating system, which was develoed by TEJ. The main risk assessment factors include: rofitability, security, activity and scale. Each factor has several reresentative financial ratios. TCI assesses risk by firstly obtaining a basic rank by the financial material that estimates a basic synthesis score by 10 financial values and the ratiohen determines a 78

2 reliminary basic rank. The next rating deends on the risk and the scale obtains the threshold rank which is, finally decided by TCI using the non-quantification factor.. Emirical Methods.1. egression Models Transaction costs theory redicts that both accounts receivable and ayable would be increased when the financial market tightens. ccording to this theoryrade credit hels to reduce cash flow uncertainty between the seller and the buyerhereby reducing the need for recautionary cash holdings for both arties. distinct characteristic of this rediction is that all firms increase accounts receivable and ayable when tighter monetary markets occur. Ferris (1981) resents evidence in suort of this theory using industry-level data. lternatively, accounts receivable (ayable) is affected by the oeration scale, by including sales (or cost for accounts ayable) in the exlanatory variables. For firm at time the asset-normalized accounts receivable are given by ln = α 1 ln t 3 4 ln 5 CP STD 6 E 7 Sale INV TCI where is nominal accounts receivable, CP is commercial aer rate-90 days, is cash and cash equivalent, INV is nominal inventories, 1 is ending-of-eriod nominal total assets, STD is short-term debts, E is retained earnings, Sale is nominal sales, TCI Taiwan cororate credit rating index, and ε is an error term. Likewisehe asset normalized accounts ayable are given by E, t 5 Cost, t 1 TCI 6 ln 7, t 8 P, t + ε + ε INV, t ln P, t = α 1 CP, t ln t 3, t 1 4 ln, t Where P is nominal accounts ayable, Cost is the nominal cost of goods sold, and ε an error term. s both accounts receivable and ayable are incurred in transactionsheir volumes are affected by the firm's oeration scale. Therefore, we include the oeration scale. Sale, for accounts receivable and Cost for accounts ayable, both of which are normalized by the lagged asset size. dditional, we include the money market interest rate, CP t in lace of the macro financial shocks when we want to take into consideration the effect of the external financing cost on trade credit. Norrbin and effett (1995) suggest that the extension of trade credit is ositively related with the interest rate because of the substitution between money and trade credit as alternative means of ayment. Ferris (1981) argues that both accounts receivable and ayable are increased with the interest rate... Determinants of Trade Credit In order to control the fixed firm effects, we only include time-varying firm-secific variables. We use the end of eriod value for a regression when the use of its current value causes a ossible endogenous roblem.. ccounts eceivable a. Sales: firm may extend trade credit more aggressively to romote sales, resulting in a ositive correlation between sales and accounts receivable. Following Petersen and aan (1997)here will be a osition correlation between sales and accounts receivable. b. (log ): If firms with more cash relative to assetshey would have more laid-u cash and be able willing to offer more trade credit. s this will be a ositive correlation between cash and accounts receivablehis variable has a ositive coefficient. c. Inventory ( INV t / t ): Inventory-based management uroses, firms with more inventories are likely to extend more trade credit than other firms. Both inventories and accounts receivable are current assets and thus are substitutes from the viewoint of asset management. d. Firm Size (log ): The effect of firm size is the roxy for market ower. From the financial assistance view suggests that large firms offer more trade credit. Contrarilyhe quality verification theory suggests that small firms have a greater need to guarantee their roduct quality than large and more established firmshus offer trade credit. Using the book value of total assets as a roxy for size, we include the log 79 (1) () P

3 of lagged assets ( ln, t ) to cature ossible nonlinearity in the size effect. e. Short-Term Debt ( STD t / t ): If this variable has a ositive coefficient, it exhibits that firms incur short-term debt to finance accounts receivable. Contrarilyhis variable has a negative coefficient; it imlies that firms extend less trade credit when short-term external financing is required. f. etained Earnings ( E t / t ): If firms with more retained earnings relative to assets have more internal caital and be able afford to offer more trade credit. g. Taiwan cororate credit rating index (TCI): TCI are divided into grades 1-9 from high risk to low risk areas. s the low-risk enterrise is more able to rovide trade credithere will be a ositive correlation between TCI and accounts receivable. Thereforehis variable has a negative coefficient. B. ccounts Payable a. Cost (log Cost): s firms need more vendor credit to finance a growing oerationhere will be a ositive correlation between the cost of goods sold and accounts ayable. b. (log ): From the sulier s viewoint, when the comany's cash flow is highhe sulier of trade credit has an advantage over other financial institutions and will be more willing to rovide credit. c. Inventory ( INV t / t ): Inventories are easy to liquidate from the sulier's viewoint. So when this ratio is highhe sulier of trade credit has an advantage over other financial institutions and will be more willing to rovide credit. d. Firm Size (log ssets): ssets size may have a ositive effect on the willingness of the trade credit roviders, since large firms usually have an established reutation, which smaller firms may not have. s Peterson and aan (1997) note, investment oortunities, which can be used as the roxy for a firm's credit demand, are tyically thought to decline in firm size for large firms this relationshi is less likely for small firms since certain roects may become viable only after enough levels of assets and exerience are acquired. e. etained Earnings ( E t / t ): From the viewoint of the suliers of trade credithe effect of retained earnings is ositive since suliers are more willing to extend trade credit to firms with more retained earnings and therefore lower default risk. On the other handhe ecking order theory (Myers (1984), and Graham and Harvey (001)) osits that firms use external financing only when internal funds are insufficient. f. Taiwan cororate credit rating index (TCI): TCI may have a ositive effect on the willingness of the trade credit roviders, since high rating usually have an established reutation, which smaller firms may not yet have. So the firm of high rating has lower default riskhe sulier of trade credit will be more willing to rovide credit. Thereforehis variable has a negative coefficient for large firms. On the contrary, smaller firms have a ositive coefficient. 3. Emirical esults 3.1. Data This aer uses firm level data of Taiwan ublic comanies that we retrieved from the Taiwan Economic Journal (TEJ) database for 1999:Q1-009:Q4. However, we excluded firms for which relevant financial variables were missing or seemed unreliable. This aroach allows us to use the data of 9,074 Taiwanese listed firms. Furthermore, we classify two different anel data sets according to the assets size. The first data set contains the to 50% of all enterrises of the firms, and the second data set contains the other 50% of all enterrises. The macroeconomic variables we used are the market interest rate and macro-financial shocks. The market interest rate, CP, is measured by the three-month Commercial Paer rate. Table 1 gives a summary of variable descritions and sources of the data. Variable Table 1 Summary of Variable Descritions and Sources Variable Character symbol Source Exected sign (+/-). TC Sulier Quarterly TEJ* The market interest rate CP Quarterly TEJ + Quarterly TEJ + Inventory INV Quarterly TEJ - Size Quarterly TEJ +/- Short-term Debts STD Quarterly TEJ +/- etained Earning E Quarterly TEJ + Sales Sales Quarterly TEJ + Credit ating Index TCI Quarterly TEJ - B. TC Demander P Quarterly TEJ The market interest rate CP Quarterly TEJ + Quarterly TEJ + 80

4 Inventory INV Quarterly TEJ + Size Quarterly TEJ + etained Earning E Quarterly TEJ + Cost of goods sold Cost Quarterly TEJ + Credit ating Index TCI Quarterly TEJ - Note:* Taiwan Economic Journal database. Suliers of trade credit are measured as natural logarithm of accounts receivable. Demanders of trade credit are measured as natural logarithm of accounts ayable. The market interest rate is measured by the three-month Commercial Paer rate. is the natural logarithm of net cash flow. Inventory is the ratio of total inventory to total assets. Size is the natural logarithm of total assets. Short-term debts are the ratio of short-term debts to total assets. eturning earning is the ratio of returning earning to total assets. Sales is the ratio of net sales to total assets. Cost of goods sold is the ratio of Cost of goods sold to total assets. Credit rating index is a cororate credit rating system which was develoed by TEJ. 3.. egressions for the ccounts eceivable Variable Table reorts the results of regressions in which the deendent variable is the accounts receivable (), as in equation (1). ll regressions henceforth, unless otherwise indicated, control for industry-secific seasonalityhereby allowing seasonality to vary across industries, and fixed firm effects. We firstly look at the estimated effects of the monetary olicy shocks. Policy shocks have a significant negative imact on the for all grous of firms. s for firm-secific variableshe cash has a strong ositive coefficient for all grous of firms. The ositive correlation between trade credit and cash is stronger for all the samles, and large enterrises are stronger than small enterrises. This result may reflect that firms with laid-u cash have extended the trade credit. The inventory has a strong negative effect for all grous of firms, esecially for large firms. The negative effects may indicate that inventories, as a buffer for internal finance, are the substitutions for accounts receivable (Carenter, Fazzari. and Petersen (1994) and Choi and Kim (001)). The size effect is characterized by a ositive and significant sign on ln, t for small enterrises. Large enterrises are not as significant as small enterrises. This findings may imly that large enterrises go through a eriod of fast growth during which they need as much financing as they can obtain from all sourceshereforehey refrain from offering trade credit. The short term debt has a significant ositive effect on accounts receivable for all samle grous of firms, esecially for large firms, imlying that firms use short-term debt to finance accounts receivable. etained earnings have no significant ositive effects on accounts receivable for all the samles. In addition, large enterrises have negative correlation and small enterrises have ositive correlation. The sale has a strong ositive coefficient for all grous of firms. The ositive link between trade credit and oeration scales is stronger for total samles and large enterrises than for small enterrises. This result may reflect that firms with sales would extend trade credit to romote sales; while those with reducing sales would reect trade credit when arting with customers. This is consistent with Ferris (1981) who indicates transaction costs theory that sellers extend trade credit to customers only when they exect a continuing relationshi. The Taiwan cororate credit rating index (TCI) has a strong negative coefficient for all grous of firmshis result show that there is a ositive correlation between trade credit and TCI for total samles. Meanwhile, we conclude that the large enterrises are more significant than small enterrises. Table egression esult for TC Sulier () (Model 1) Variable Symbol Total Samles Large Enterrises Small Enterrises ( 50%) (<50%) Commercial aer rate CP 0.11*** 0.10*** 0.103*** (6.538) (5.146) (4.168) 0.168*** 0.40*** 0.099*** (13.59) (13.375) (5.54) Inventory INV -1.70*** -1.83*** *** (-19.84) ( ) ( ) Total ssets 0.65*** 0.553*** 0.890*** (46.059) (4.557) (8.058) Short-term Debts STD 1.178***.146*** (9.841) (1.97) (0.067) etained Earning E *** 0.108** (1.551) (-5.046) (.19) Sales Sales 1.619*** 1.845*** 1.396*** (41.598) (3.061) (6.680) Credit ating Index TCI *** *** *** (-1.935) (-13.93) (-4.003) Observations d Table summarizes the estimated results of equation (1), which regress the natural logarithm of, firm-secific variables (detailed in Section ), and olicy shocks (CP). egressions using ordinary least squares are erformed with the Taiwan ublic data (9074) for the 1999Q1-009Q4 eriod. ll regressions control for fixed firm. The adusted excludes variance exlained by the fixed firm effects. The t-values in arentheses are based on Whites correction for heteroskedasticity. ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, resectively. 3.3 egressions for the ccounts Payable Variable The regression results are summarized in Table 3. Tighter olicy can increase the P significantly for the total samles. Firsthe roviders of trade credit are concerned about the default risk of the buyer. Second, 81

5 they are concerned about the ossibility of selling the reossessed sulies in case of any defaults, accounts ayable are constrained by the willingness of the roviders of trade credit. So, we should consider about the determining factors of the suliers and the demand of trade credit as well. s for firm-secific variables in Table 3he cash has a strong ositive coefficient for all grous of firms. The ositive correlation between trade credit and cash is stronger for the total samles, and large enterrises are stronger than for small enterrises. It imlies that the roviders of trade credit avoid the default risk of the buyers since they have a high cash flow. Inventory always has a ositive effect on accounts ayable, and its estimate is higher for large enterrises than for small enterrise. This result is consistent with the exlanation that accounts ayable can be issued against inventories, esecially for smaller firms, since inventories can be easily liquidated. negative and significant sign on ln, t for large firms. It imlies that large firms deend less on accounts ayable because large firms are more likely than small firms to obtain source of caital from other financing channels. etained earnings have a ositive effect on the accounts ayable for small enterrises, reflecting that firms with more internal caital would need less external shortterm financing. For large enterrises, however, retained earnings have insignificant effects on accounts ayable. The cost of goods sold has a strong ositive effect on the account ayable for all grous of firms, and its estimate is higher for large enterrises than for small enterrise, similar to the ositive relation between the cost of goods sold and the accounts ayable. That is, large firms use relatively more accounts ayable during their oeration if comared to smaller firms, imlying that large firms have the market ower to squeeze more trade credit from their suliers. The Taiwan cororate credit rating index (TCI) has a strong negative coefficient for large firmsotal samles and small firms is insignificanthis result show that the ositive correlation between trade credit and TCI is stronger for large enterrises. From the viewoint of risk management by credit suliershe effect is ositive since the suliers will be more willing to extend the trade credit to firms with higher credit rating and lower default risk. Table 3 egression esult for TC Demander (P) (Model ) Variable Symbol Total Samles Large Enterrises Small Enterrises ( 50%) (<50%) Commercial aer rate CP 0.089*** 0.076*** 0.107*** (5.384) (3.116) (4.956) 0.07*** 0.87*** 0.143*** (17.405) (15.57) (9.397) Inventory INV 1.3*** 1.745*** 0.59*** (15.965) (16.09) (4.94) Total ssets 0.03** *** 0.7*** (.063) (-7.058) (9.98) etained Earning E *** 0.19*** (0.861) (-7.09) (.907) Cost of goods sold Cost 0.77*** 0.805*** 0.66** (7.78) (45.653) (57.67) Credit ating Index TCI *** (-1.65) (-5.074) (0.749) Observations d Table 3 summarizes the estimated results of equation (), which regress the natural logarithm of P, firm-secific variables (detailed in Section ), and olicy shocks (CP). egressions using ordinary least squares are erformed with the Taiwan ublic data (9074) for the 1999Q1-009Q4 eriod. ll regressions control for fixed firm. The adusted excludes variance exlained by the fixed firm effects. The t-values in arentheses are based on Whites correction for heteroskedasticity. ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, resectively. 4. Conclusion Trade credit is an imortant source of financing, because it reresents a maor ortion of the short-term financing of firms and lays an imortant role in the monetary olicy. We find that firms have increased both accounts receivable and accounts ayable, which means that the interfirm liquidity market becomes more active under the tighter olicy. ccounts receivable and accounts ayable are also relatively increased with the interest rate; suorting the viewoint that the trade credit is used as a substitute for bank loans in order to enhance loan efficiency. There is articularly noteworthy in this aer. First, a strong effect between trade credit and the cash flow suggests that firms have high oerating cash flow would be helful on trade credit at the onset of recessions. Secondhis study adots the variable of credit rating (the Taiwan cororate credit rating index, TCI), for the first time to be analyzed in the literatures, and our results show that TCI has a strong ositive effect on the account receivable for all grous of firms, as well as on 8

6 the account ayable for large firms. In other wordshose firms have an excellent reutation for extending the trade credit. 5. eferences [1]. E. Carenter, S. M. Fazzari and B. C. Petersen. Inventory Investment. Internal-Finance Fluctuations and the Business Cycle. Brookings Paers on Economic ctivity. 1994, [] W. G. Choi and Y. Kim. Monetary Policy and Cororate Liquid sset Demand. IMF Working Paer 01/177, 001. [3] W. G. Choi and Y. Kim. Trade credit and effects of macro-financial shocks: Evidence from US anel data, Journal of Finance and Quantitative nalysis.005, 40(4): [4] J. S. Ferris. Transaction Theory of Trade Credit Use. Quarterly Journal of Economics.1981, 96: [5] M. Gertler and S. Gilchrist. The ole of Credit Market Imerfections in the Monetary Transmission Mechanism; rguments and Evidence. Scandinavian Journal of Economics. 1993, 95: 43-64, [6] J.. Graham and C.. Harvey. The Theory and Practice of Cororate Finance: Evidence from the Field. Journal of Financial Economics. 001, 60: [7]. H. Meltzer. Mercantile Credit. Monetary Policy and the Size of Firms. eview of Economics and Statistics. 1960, 4: [8] S. C. Myers. The Caital.Structure of Puzzle. Journal of Finance. 1984, 39: [9] J. H. Nilsen. Trade credit and the bank lending channel. Journal of Money, Credit, and Banking. 00, 34(1): [10] S. C. Norrbin and K. L. effett.: "Trade Credit in a Monetary Economy" Journal of Monetary Economics. 1995, 35: [11] M.. Petersen and. G. aan. Trade Credit: Theories and Evidence, eview of Financial Studies. 1997, 10(3):