We propose a simple theory to account for the prevalence of interfirm credit at an interest rate of zero. A downstream firm trades off inventory holding costs against lost sales. Lost final sales impose a negative externality on the upstream firm. The solution requires a subsidy limited by the value of inputs. Allowing the downstream firm to pay with a delay is precisely such a solution. A reverse externality accounts for the use of prepayment. We clarify how input prices
vary with such policies, and when trade credit/prepayment is more efficient than pure input price adjustments. (JEL D21, D62, D92, G31, L25)
"Ensuring Sales: A Theory of Inter-firm Credit."
American Economic Journal: Microeconomics,
Firm Behavior: Theory
Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
Firm Performance: Size, Diversification, and Scope