Inventory, renegotiation, and trade credit

The paper uncovers a novel benefit of trade credit financing: the elimination of agency frictions from renegotiation between a financially constrained buyer and a seller. The two parties agree on the price and quantity of a good to trade. If the buyer later receives an unfavorable demand signal, the two parties negotiate a partial return of the good to the seller. We compare the efficiency of the renegotiation and the initial trade agreement under bank financing and under trade credit financing. Whereas renegotiation under bank financing leads to risk shifting and inefficient outcomes, renegotiation under trade credit financing internalizes the interests of the lender, and results in the first-best equilibrium. This benefit of trade credit financing increases with demand uncertainty, precision of the demand signal, salvage value of the good, and the seller’s bargaining power vis-`a-vis the buyer.

renegotiation -- JF submission June 25 2025.pdf

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