PRAIRIE VIEW, Texas (September 24, 2020) – In predictable economic times, businesses operate under a system of trade credit. A company will buy goods from another company, but it may not pay for the goods for up to 30 days or more, depending on trade credit policies and the two companies’ trade credit agreement.
So, what happens when economic policy is uncertain, and businesses can’t gauge which way the economic winds will blow? Do companies adjust their trade credit policy? If so, how does it affect shareholder value during economic uncertainty?
Prairie View A&M University (PVAMU) Associate Professor of Finance Hinh D. Khieu set out with a team of researchers from the United States and the United Kingdom (UK) to find out how economic policy uncertainty, or EPU, affects trade credit policies. The timing of this research turned out to be unexpectedly on point, as global economies were hit with the extreme uncertainty of the COVID-19 pandemic as the team was preparing to release their findings.
Khieu’s team, which includes Surendranath R. Jory from the University of Southampton, UK, Thanh N. Ngo from East Carolina University, and Hieu V. Phan from the University of Massachusetts Lowell, presented their peer-reviewed research in the Journal of Corporate Finance.
The publication is rated A+, the highest rating available, by the Australian Business Deans Council.
“A publication in a journal of this caliber takes several times greater time and effort than publishing in a regular peer-reviewed journal. I am proud and happy for Professor Khieu and his team of co-authors on this success,” said College of Business Dean Munir Quddus, Ph.D.
For the research, the team narrowed their focus to U.S. public firms and examined a sample of more than 288,000 quarterly financial records from 11,196 U.S.-based firms between 1985 and 2016. With this data in hand, they used an EPU index, created in 2016, to analyze whether there was a connection between economic policy uncertainty over the years and trade credit policies.
The results showed trade credit policies tend to become more conservative during times of uncertainty. However, the team’s research added layers to previous studies on this subject.
“We find that firms curtail their receivables periods and face shorter payables periods from suppliers during high economic policy uncertainty (EPU),” the team reported in the journal.
Trade credit policies do appear to be more conservative during high EPU, so firms have shorter periods to pay for products and materials. However, previous studies suggested large firms with high market power might have been able to leverage that market power to their advantage.
This new research did not find that to be the case.
“[T]he negative effect of EPU on trade credit is consistent and broadly independent of firms’ products and services, degrees of financial constraints, market power, relationship-specific clients, and importance of sales to the government. We attribute the findings to the systemic nature of economic policy uncertainty, i.e., it tends to have a profound impact on all businesses along the supply chain,” the team reported.
“Professor Khieu and his co-authors find compelling evidence that increased uncertainty impacts firm decisions when it comes to international trade, but the impact is not always as expected,” Quddus said.
As to whether trade credit policy changes would affect shareholder value, the team found a risk that companies should know.
Hinh D. Khieu
“Our evidence indicates that an overly conservative trade credit policy implemented during the periods of high EPU might drive customers to competitors. Our study has important implications for corporate managers regarding firm risk and liquidity as well as policymakers on the market-wide consequences of their policy decisions,” they said.
Companies may become more conservative during uncertainty, but becoming too conservative puts the firm at risk of losing business and lowering shareholder value. These findings give finance and risk management teams data to work with when deciding how to adapt to uncertain economic times.
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By Jocelyn Kerr