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Interfirm Relationships And Informal Credit

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If the customer default, the supplier may refuse to provide credit next time or ... are enduring, suggesting that networks are used to sanction defaulting customers. ... – PowerPoint PPT presentation

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Title: Interfirm Relationships And Informal Credit


1
Interfirm Relationships And Informal Credit
  • By John McMillan and Christopher Woodruff

2
  • In developed countries, well functioning legal
    system exists. Contracts are enforced through
    specific institutions such as the courts.
  • However, in most developing countries, laws of
    contract are inadequate. Informal relationships
    substitute for the courts in allowing deals to be
    made.

3
  • The aim of this paper is to provide empirical
    evidence of relational contracting.
  • Particularly, it studies what determines the
    level of business trust. The measure of business
    trust is the fraction of the payment made after
    delivery of the goods.

4
  • Relational contracting is can be regarded as a
    repeated prisoner dilemma game. The customer
    chooses between a short-term gain and a long term
    relational value.
  • If the customer default, the supplier may refuse
    to provide credit next time or not trade with the
    customer any more. Moreover, other suppliers may
    know about this and make their decisions of trade
    and credit grand accordingly.

5
  • What determines the suppliers trust according to
    the model?
  • The customers ability to find alternative
    trading partners
  • The suppliers gathering of information about the
    customer
  • Network relationships

6
  • First hypothesis customers lacking alternative
    suppliers will receive more trade credit.
  • It is because there are higher long run
    relational value. The Customer would have higher
    cost of search for another supplier or larger
    transport costs in buying from another supplier.

7
  • Second hypotheses There will be more trade
    credit when the supplier inspects the customer
    directly and in relationships of longer duration
  • The suppliers direct dealings with the customer
    might yield information about its
    creditworthiness.
  • Cooperation might build up gradually as the
    supplier learns through trading about the
    customers reliability.

8
  • Third hypotheses a supplier belonging to a
    network will grant more trade credit.
  • A network might provide information.
  • Networks provide not only information about
    customers reliability but also extra ability to
    sanctions customers who renege.

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10
Data
  • Data come from surveys of 259 nonstate firms in
    Vietnam
  • Two waves firms in Hanoi in 1995-1996 and Ho Chi
    Minh City in 1997.
  • Firms were drawn from lists of members of the
    Vietnam Chamber of Commerce and Industry. There
    may be potential sample selection problem and
    therefore the results may not be easily
    generalized.

11
  • The survey contains information on 518
    manufacturer customer relationships and 518
    manufacturer supplier relationships.
  • State owned enterprises are eliminated. Also,
    relationships no longer ongoing are dropped. We
    end up with a sample of 242 customer
    relationships and 254 supplier relationships.
    Complete data are available for 224 customer and
    243 supplier relationships.

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13
  • All are manufacturers.
  • Most firms are new, with less than 4 years age.
    The duration of trade relationship may capture
    this dimension of firms characteristics.
  • Most sales go to customers in the same city as
    the respondent. This is not the case for large
    firms which export more than a third of their
    production on average.
  • One firm involves in more than one trading
    relationships.

14
  • The heart of the survey is a series of questions
    about the firms relationships with its first
    customer and its most recently added customer
    and with it longest running supply relationship
    and its newest supply relationship.
  • For each of the four specific relationships,
    firms were asked what proportion of the sales
    price is paid in advance of delivery, at the time
    of delivery, and after delivery.

15
  • The portion of the bill paid after delivery is
    used as a measure of credit supply.
  • Observed trade credit is the outcome of the
    supply of credit offered to the customer and the
    customers demand for credit. However, the
    authors argue that it does not matter since the
    demand for credit is not correlated with the
    independent variables.

16
Empirical method
  • The level of credit is treated as a censored
    variable, with the desired level of credit
    observed only when it falls between zero and 100
    percent.
  • latent equation
  • The observed level of trade credit offered
    customer i is

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18
  • visited customer before first sale, currently
    visit customer at least weekly, and talk to
    other suppliers of customer at least monthly are
    at first excluded from the regression, because
    there is concern about their endogeneity.
    Suppliers providing credit to a customer may have
    a higher incentive to collect information about
    that customer
  • Column (3) adds variables suggested by the
    literature of trade credit. Column (4) adds
    controls related to manufacturer and manager
    characteristics. These additional variables have
    little effect on the relational contracting
    coefficients.

19
  • Column (5) through (8) examine whether these
    determinants of the willingness to offer credit
    vary depending on whether the manufacturer is
    selling domestically or overseas, or whether the
    manufacturer is large or small

20
  • Some econometric suggestions
  • marginal effect does not equal to the coefficient
  • the sign is right, but the magnitude is wrongly
    reported in the table
  • One firm has several trade relationships.
    Therefore, the error term may be correlated
    within one firm. This leads to biasness in a
    Tobit model. Measurement error of the dependent
    variable may also bring in some biasness.
  • Samples are divided according to the suppliers
    size and whether its customer is domestic or
    overseas. In this way, we cannot easily tell
    whether the marginal effects are significantly
    different from each other. A more nature way is
    to add the interaction terms to deal with the
    random coefficient model.

21
  • Network membership provides a manufacturer both
    information about the reliability of trading
    partners and the ability to sanction.
  • Information about the reliability of a customer
    is most valuable at the beginning of a
    relationshipthe effect diminishes over time
  • Ability to sanction has more enduring
    effectconstant effect over time

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23
  • Interations of the network membership variables
    with duration
  • The chi-square tests indicate that the additional
    variables are not jointly significant for the
    network variables. The authors conclude that
    sanctions are a significant role of the business
    networks.
  • Also interact visited customer before first
    sale with duration as a robust check. It shows
    diminishing effect over time.

24
  • The survey also contains data on trade credit
    received by the interviewed manufacturers from
    their longest continuing supplier and their
    newest supplier.
  • Trade credit received from suppliers is similar
    in magnitude to that granted to customers. It can
    also be used as the dependent variable as a
    measure of suppliers trust.
  • The advantage of using customer data is that we
    can control direct measure of creditworthiness of
    the customerreceiving loans from banks

25
  • Data on the manufacturers degree of lock-in to
    its supplier are provided by a question on how
    long it would take them to find alternative
    supplier in the event a supplier failed to
    deliver goods as promised.
  • Measure of social networks is whether the
    supplier was managed by someone who was a family
    member or friend when the trading relationship
    started.
  • Measure of business networks is whether its
    suppliers talked among themselves.

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28
conclusion
  • A firm trusts its customer enough to offer credit
    when the customer finds it hard to locate an
    alternative supplier.
  • The firms experience in dealing with the
    customer matter a longer duration of trading
    relationship is significantly associated with
    larger credit, at a rate that diminishes over
    time.
  • Visiting a customer or supplier before the
    business relationship starts is associated with
    10 points more credit in the first year of the
    relationship, although the effect diminishes over
    time.

29
  • a customer identified through a business network
    receives ten to twenty percentage points more
    credit.
  • When the firm talks regularly with other
    suppliers of the customer, it grants about 20
    points more credit.
  • The network effects are enduring, suggesting that
    networks are used to sanction defaulting
    customers.
  • Relational contracting is ambiguously
    efficiency-enhancing. Continuing to deal with the
    custom might mean refusing to deal with new
    entrants, which could result in some
    inefficiencies.
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