We propose to develop a liquidity-based theory of commercial (short-term) lending. Our central argument is that cash is easily diverted to ventures with large private benefits, while physical inputs are less liquid and hence less subject to moral hazard. In addition, suppliers observe the input transaction as a costless by-product of their sales activities. This explains why credit from suppliers is an important source of (short-term) lending. In addition, we intend to explore the implications of our theory for the use of factoring, priority rules in bankruptcy, and vertical integration.
One test of the theory will be to fit it to available detailed firm-level evidence. In addition, we hope to explain historical developments as well as cross-country differences in the use of trade credit, such as its more prominent role in the United States relative to Italy. In our view, the issues addressed in this project are of broader relevance. Some countries, e.g., transition economies, are in the process of designing a whole new set of institutions. Others, like Sweden, are closely reviewing their laws and regulations. The impact of credit conditions on the monetary policy transmission provides yet another reason why microeconomic foundations of trade credit are of interest.