Financial Development and Trade Credit: Moderating Role of Corruption

Abstract

There exists extensive literature on trade credit as secondary source of financing, but few studies have found that how financial development change the preference of trade credit financing specifically in high corruption environment. The objective of this study is to examines this relationship because substitution theory vows that trade credit assists the firms to mitigates the challenges of low financial development. Ten years data ranging from 2007 to 2016 of non-financial sector firms from three countries (Pakistan, China, and India) were used and GMM (generalized method of moments) fixed effect model employed for regressing analysis. Results first reveal that if a country has low financial development, companies can arrange their financing needs through secondary source of financing i.e. trade credit. Trade credit is an alternative source of financing during low financial development. It then suggests that high corruption hampers the option of trade credit financing as it creates the more uncertainty for business. In high corruption situation, companies use more bank financing.В  But this effect become positive when corruption interacts with financial development and collectively effect the trade credit. High corruption and high financial development mitigate each other effect and thus companies go towards more trade credit financing. Overall, evidence suggests that the trade credit is a substitute source of low financial development. Corporate managers can reduce the probability of adverse effects of low financial development by utilizing the more financing through trade credit.