Counter-cyclical substitution between trade credit and bank credit

This paper explores the substitution relationship between trade credit and bank credit, and its counter-cyclic dynamic pattern through economic cycles. We propose a new theoretical model, using a mechanism design method, which predicts the substitution between the two credits and its counter-cyclic behavior, subject to the condition of technological efficiency not less than one. This model also helps explain the somewhat contradictory evidence in the literature, on the relationship between the two credits. We present empirical evidence on the substitution effect and its counter-cyclic behavior, by using a balanced panel data set of 284 listed Chinese companies for the period 1998-2006. We further find that the substitution behaves counter-cyclically with respect to the coincident macroeconomic indicator, namely, GDP. Our empirical analysis also has some new features such as treating endogeneity carefully and incorporating the lag-effect of trade credit coherently.