Cash as Substitute for Enforcement Power : A Theory of Trade Credit and Evidence from China

This paper studied the governance mechanism of the economic transaction with trade credit: First, we build a theoretical model that bargaining power reduces trade credit ex ante, and expand ex post enforcement power. The ex post enforcement power and cash in the buyer's hand expand the trade amount and trade credit in the presence of default risk. Empirical results support the prediction from the model: seller' ex post enforcement power determines the size of trade credit and trade amount; seller's bargaining power reduces trade credit and trade amount for avoiding default risk, but improves enforcement power; cash in hand of the buyer can be a substitute for enforcement power. This study finds that we need to distinguish the impact of the two party bargaining power from that of the third party's enforcement power. Cash-enforcement relationship may explain the importance of the mobile payment application