Benefits and Costs of Having Bank and Trade Credit Simultaneously

Abstract

This paper provides a rationale for the question whether to have bank debt only or bank and trade credit simultaneously. In the two creditors case a special incentive problem might occur prior to bankruptcy if the bank loan is secured by external collateral. In order to save her private fortune, the entrepreneur may be tempted to repay the bank by liquidating the firm's assets before bank debt becomes due. Even the bank might benefit. The unsecured supplier will lose. With pure bank financing - thus, paying the supplier via the bank account - the problem does not occur. However, then the supplier may have poor incentives to provide nonverifiable services later on. Collateral and short-term dates of payments mitigate the entrepreneurial moral hazard problem.