Trade credit is commonly perceived to exacerbate supplier risk, as delayed payments expose the supplier to buyer uncertainties. In contrast, cash on delivery (COD) is viewed to be safe, as it insulates the supplier from downstream risk. Using a stylized game-theoretic model, we show that this conventional wisdom can be overturned when the supplier is dual-channel, with a direct channel that sells to customers in addition to an indirect channel that sells to a buyer who then sells to the same customers. Compared to COD, trade credit induces the buyer to engage in risk-shifting and to order more. Although generally perceived a distortion, we find that this over-ordering behavior can benefit the supplier by reducing its bankruptcy risk. This is because over-ordering leads to higher buyer payment than under COD precisely when the supplier needs it most, i.e., when the supplier has weak market sales due to losing customers to the buyer, who thus has strong sales and fully repays trade credit. This pooling effect can also mitigate or even eliminate the adversarial impact of buyer trade credit defaults, because such scenarios may imply the buyer losing customers to the supplier, whose subsequent strong market sales compensate for the low trade credit payment. Therefore, joint over-ordering and pooling effects can outweigh the risk-worsening effect of trade credit and decrease the supplier’s bankruptcy risk. We empirically validate the risk mitigation effect of trade credit using data on manufacturing firms that sell to their competitors. We show that a supplier’s bankruptcy risk, measured by the Ohlson O-score and Merton distance-to-default, decreases with its accounts receivable after selling to competitors. These effects are concentrated on suppliers that have low leverage or high competition intensity with their buyers, consistent with our theory.
