Trade Credit and firm Comovements

This paper provides evidence that production linkages, as well as credit chains (represented by trade credit), are important for the transmission of idiosyncratic (firm-level) shocks across firms in the economy. We build on the idea that trade credit develops along production linkages, and amplifies the idiosyncratic shock as firms may lack inputs and also liquidity. Using disaggregated firm-level data we show that the disturbance of customer's sales increases with greater trade credit linkage.
We show that during a recession the existence of trade credit linkage propagates shocks upstream, from a supplier onto its upstream customer. In these periods, firms are short of liquidity and are unable to withstand a drop in trade credit provision. In good times, however, trade credit plays a stabilizing role, reducing the volatility of firms' sales. In these periods, firms with sufficient liquidity are able to transfer some of it to liquidity-starved production partners in order to guarantee their own stable production.