Theories of Trade Credit: Limitations and Applications

Substantial work has been done during the past three decades to determine the theories of trade credit. But as observed by Frank and Maksimovic (1998), though the theories apply in specific circumstances, they are unable to explain the widespread use of trade credit and the empirical patterns of its use. Long, Malitz and Ravid (1993) also held that although trade credit is a very useful source of finance for different firms, its explanation, as yet, is not very clear. In this article we shall present a critical evaluation of each of these theories, highlight the problems associated with it and indicate specific areas of its application.