Determinants of Trade Credit in Pakistan and Role of Financial Development and Credit Information Sharing

Abstract

Determinants of Trade Credit in Pakistan and the Role of Financial Development and Credit Information Sharing In developing countries, where financial markets and financial institutions are not welldeveloped, the usage of trade credit is high. Pakistan is characterized by a relatively underdeveloped financial system where most of the nonfinancial firms are credit rationed by financial institutions. However, listed manufacturing firms (LMFs) have access to both financial market and financial institutions. The simultaneous use and extension of trade credit by LMFs shows that these firms redistribute credit to their credit constrained customers in Pakistan. The aim of this study is two-fold. First, this study investigates the effects of the financial characteristics of LMFs on trade credit extended and trade credit used by these firms. Second, this study examines the effect of financial development (FD) and credit information sharing (CIS) on the credit redistribution by LMFs in Pakistan. A dynamic panel model (DPM) is estimated by applying the system GMM (one and two-step) estimator to the financial data of 327 manufacturing firms listed on the Pakistan Stock Exchange (formerly known as the Karachi Stock Exchange) for the time period between 2005 and 2015. The results of the study reveal that trade credit extended and trade credit used by LMFs are dynamic and are significantly affected by the financial characteristics of these firms. Trade credit extended by firms is positively related to credit received from suppliers and banks. This finding is consistent with the credit redistribution hypothesis. Furthermore, the simultaneous use of both trade credit and short-term bank credit by LMFs shows that these firms follow the optimal capital structure policy. The findings of the study also show that depth of financial institutions (DFIs) and depth of financial market (DFM) are quasi-moderators and have a buffering effect on the credit redistribution by LMFs. While, lending rate enhances the credit redistribution by LMFs in Pakistan. The findings suggest that credit managers should consider the persistence of their trade credit policies and changes in the financial characteristics of their firms while adjusting the trade credit policies. Furthermore, managers of LMFs should revise their trade credit policies in response to improvements in the level of FD and CIS.