Financial Contracting and Organizational Form: Evidence from the Regulation of Trade Credit

We present empirical evidence that restrictions to the set of feasible financial contracts affect buyer-supplier relationships and the organizational form of the firm. We exploit a regulation change that restricted the maturity of the trade credit contracts that a large retailer could sign with its small suppliers, defined by an arbitrary sales cutoff, to at most 30 days. Using a within-product differences-in-differences identification strategy, we find that the restriction to the set of feasible contracts reduces the likelihood that trade takes place by 11%. The large retailer responds by internalizing the procurement of some products previously sold by affected firms to its own subsidiaries but reduces the volume of purchases, consistent with the fact that vertical integration is costly. Thus, financial contracts like trade credit may help overcome contracting frictions and enable trade.