Trade Credit, Cash Holdings, And Financial Deepening

7/25/2019 Trade Credit, Cash Holdings, And Financial Deepening

1/16

Trade credit, cash holdings, and financial deepening:Evidence from a transitional economy

Wenfeng Wu a, Oliver M. Rui b, Chongfeng Wu a,

aAntai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, Chinab China Europe International Business School 699 Hongfeng Road, Pudong Shanghai, China

a r t i c l e i n f o

Article history:

Available online 24 April 2011

JEL classification:

G31

G32

Keywords:

Cash

Trade credit

Financial deepening

Receivables

Payables

a b s t r a c t

This paper investigates the effect of financial deepening on the relationship between trade credit and cash

holdings among Chinese listed firms. We first document an asymmetric effect of trade payables and

receivables on cash holdings, in that firms hold an additional $0.71 of cash for every $1 of credit payable

but use $1 of receivables as a substitute for only $0.15 of cash. We then find that firms in regions with

higher levels of financial deepening hold less cash for payables while substituting more receivables for

cash. A more highly developed financial sector helps firms to better use trade credit as a short-term

financing instrument. Finally, we find that the ratio at which receivables are substituted for cash

increased following the implementation of the new receivables pledge policy in 2007, which allowed

firms to use receivables as security for loans. This policy event represents an exogenous shock that mit-

igates the endogeneity concern.

2011 Elsevier B.V. All rights reserved.

1. Introduction

Previous studies have found that trade credit constitutes a large

proportion of total assets. Rajan and Zingales (1995) find that the

ratio of aggregate trade credit to total assets was 17.8% for US firms

in the early 1990s.Bartholdy and Mateus (2008)show that this ra-

tio ranges between 16% and 24% across sixteen European countries.

According to the literature, firms use trade credit as a substitute

form of short-term finance to conventional institutional loans,

especially if they have been denied access to the institutional loan

market (Petersen and Rajan, 1997; Fishman and Love, 2003).1

Although firms can delay payment to their suppliers through

trade credit, they still need to hold some cash for forthcoming

trade credit obligations. Late trade credit payments have costs,

such as the cost of forgoing a possible cash discount, the possibility

of incurring late payment penalties, the opportunity cost associ-

ated with a possible deterioration in credit reputation, and a possi-

ble increase in the selling price set by the seller. At the same time,

firms often take on different roles in trade credit transactions.

Many companies, particularly those at intermediate points in the

value chain, use trade credit as a customer and provide it as a sup-

plier. As a supplier of trade credit, a firm can accept credit receiv-

ables as a cash substitute by, for example, factoring receivables or

using them to secure loans. Consequently, trade payables and

receivables both have effects on firms cash holdings: payables in-

crease cash holdings, while receivables have the opposite effect.

As cash is not productive, firms prefer to hold less cash for pay-

ables and expect to be able to substitute more receivables for cash.

The sensitivity of cash holdings to payables and receivables is af-

fected by many factors including the nature of the firms payables

and receivables and the firm characteristics of suppliers and cus-

tomers. In this study, we focus on another significant factor: the

institutional finance environment. More specifically, we investi-

gate how financial deepening affects the sensitivity of cash hold-

ings to trade credit.

In the strand of literature that documents the importance of the

financial system to economic growth (Dornbusch and Reynoso,

1989; Hasan et al., 2009), development of the financial sector is

seen to improve the performance of financial intermediaries,

which in turn provides the industrial sector with better financial

services. Firms can consequently gain access to finance more easily

and at a lower cost. This leads to a lowering of the cost of cash

shortages for trade payables. In addition, a deeper financial sector

increases the substitute ratio of receivables for cash, as firms can

factor receivables more easily or use them to secure loans from

financial intermediaries at a lower cost. We thus hypothesize that

0378-4266/$ - see front matter 2011 Elsevier B.V. All rights reserved.doi:10.1016/j.jbankfin.2011.04.009

Corresponding author. Tel.: +86 21 5230 1194; fax: +86 21 5230 1087.

E-mail addresses: [email protected] (W. Wu), [email protected]

(O.M. Rui), [email protected](C. Wu).1 Giannetti et al. (2011) provide a review of these theories. Some theories

emphasize operations-oriented motives such as informational advantage, price

discrimination, switching costs, product quality guarantees, and the profitability

problem. Other theories focus on financial motives including the collateral hypothesis

and the repayment enforcement hypothesis.

Journal of Banking & Finance 36 (2012) 28682883

Contents lists available at ScienceDirect

Journal of Banking & Finance

j o u r n a l h o m e p a g e : w w w . e l s e v i e r . c o m / l o c a t e / j b f
http://dx.doi.org/10.1016/j.jbankfin.2011.04.009mailto:[email protected]:[email protected]:[email protected]://dx.doi.org/10.1016/j.jbankfin.2011.04.009http://www.sciencedirect.com/science/journal/03784266http://www.elsevier.com/locate/jbfhttp://www.elsevier.com/locate/jbfhttp://www.sciencedirect.com/science/journal/03784266http://dx.doi.org/10.1016/j.jbankfin.2011.04.009mailto:[email protected]:[email protected]:[email protected]://dx.doi.org/10.1016/j.jbankfin.2011.04.009


2/16

firms in regions with higher levels of financial deepening hold less

cash to cover trade payables and have a higher substitute ratio of

receivables for cash.

Like their counterparts in other countries, Chinese firms exhibit

high ratios of trade credit to assets. Trade payables and receivables

represented 11% and 15%, respectively, of the total assets of Chi-

nese listed firms over the period from 1999 to 2009. There are also

great variations in institutional quality across Chinese regions (Jinet al., 2005), and the levels of financial deepening across regions

are uneven. These characteristics make China a natural laboratory

for a cross-sectional investigation of whether and how financial

sector development shapes the relationship between trade credit

and cash holdings. In 2007, China promulgated a new receivables

pledge policy that officially allowed firms to use receivables as col-

lateral for bank borrowings. This policy event represents an exog-

enous shock that affords us the opportunity to examine the

influence of financial deepening on the sensitivity of cash holdings

to trade credit and mitigates concerns over endogeneity.

Using data from Chinese listed firms over the period from 1999

to 2009, we find that firms need to hold an additional $0.71 of cash

for every $1 of credit payable, whereas $1 of credit receivable sub-

stitutes for only $0.15 of cash. This finding is not consistent with

the traditional wisdom that $1 of credit receivable covers $1 of

credit payable in cash. Firms with zero net trade credit (those for

which credit payable equals credit receivable) still need to hold

cash for payables. This asymmetric influence of payables and

receivables on cash holdings suggests that past studies may have

drawn biased conclusions by treating net trade credit as just one

component of working capital in estimating its impact on cash

holdings. It is more appropriate to disentangle the impacts of pay-

ables and receivables on cash holdings, as they are separate and

different from each other.

We also find that Chinese firms in regions with higher levels of

financial deepening hold less cash to cover trade payables and have

a higher substitute ratio of credit receivables for cash. Additionally,

we find that the new receivables pledge policy introduced in 2007

has exerted a considerable impact on the sensitivity of cash hold-ings to trade receivables, with the substitute ratio of receivables

for cash increasing significantly following implementation of the

new policy. This effect is stronger in firms located in regions with

higher levels of financial deepening. However, the new receivables

pledge policy does not affect the sensitivity of cash holdings to

trade payables, as it does not involve trade payables. Overall, these

results show that development of the financial sector helps firms

to mitigate the asymmetric impact of trade payables and receiv-

ables on cash holdings. A higher level of financial deepening im-

proves the short-term financing function of trade credit.

Furthermore, we analyze the influence of related-party trades

and state ownership on the sensitivity of cash holdings to trade

credit. We find that state-owned enterprises (SOEs) and firms that

have engaged in related-party trades hold less cash to cover pay-ables and have a higher substitute ratio of receivables for cash. In

addition, related-party trades and state ownership have substitute

effects for financial deepening on the relationship between trade

credit and cash holdings. The new receivables pledge policy has a

stronger effect on the sensitivity of cash holdings to receivables

in both firms that conduct related-party trades and SOEs, but its ef-

fect on the sensitivity of cash holdings to payables is not different

for related-party trade firms and state-owned entities. These re-

sults not only support our hypothesis, but also partially address

the concern that factors other than financial deepening or the

new receivables pledge policy drive our results at the province-

year level, as related-party trades and state ownership are firm-

specific, but are not related to the province-year level.

This study contributes to the literature in several ways. First, itextends research on the impact of financial deepening (Dornbusch

and Reynoso, 1989; Hasan et al., 2009). It investigates the influence

of financial deepening at the micro level by linking two important

firm operations: trade credit and cash holding policies.2 We dem-

onstrate that financial deepening can help firms to make better

use of trade credit as a short-term financing instrument.

Second, we enrich existing studies on trade credit. Most of the

literature on trade credit focuses on why firms extend and take

credit (Petersen and Rajan, 1997; Cunat, 2007; Giannetti et al.,2011). This study instead examines how trade credit influences

the firms operations or, more specifically, its cash management

policy. Our finding that payables and receivables exert different

impacts on cash holdings deepens our understanding of the differ-

ence between the demand and supply sides of trade credit.

Third, this study complements research on the determinants of

cash holdings (Opler et al., 1999; Dittmar et al., 2003; Ozkan and

Ozkan, 2004; Dittmar and Mahrt-Smith, 2007; Guney et al.,

2007). Past studies have not examined trade credit as a separate

determinant of cash holdings (Opler et al., 1999; Dittmar and

Mahrt-Smith, 2007).3 However, our results show that trade credit

plays a significant role in explaining cash holdings, as it increases

the explanatory power of the regression model of their determi-

nants. Furthermore, the asymmetric influence of credit payables

and credit receivables indicates that it is better to disentangle their

distinct effects in considering their overall impact on cash holdings.

Finally, we find that the ratio at which receivables are substi-

tuted for cash has increased since implementation of the new

receivables pledge policy in 2007 allowing firms to use receivables

as security for loans, which represents a deepening of the financing

environment. This policy event also represents an exogenous shock

that mitigates concerns over endogeneity, which are common in

corporate finance research (Li and Prabhala, 2005).

The remainder of the paper is organized as follows. Section 2

introduces the institutional background on bank lending in Chi-

nese firms, the use of trade credit, and the 2007 receivables pledge

policy. Section3develops the hypotheses. Section4 describes the

data, variables, and methodology. Section5presents the empirical

results and Section6 concludes the paper.

2. Institutional background

2.1. Banking lending in Chinese firms

The Chinese financial system is dominated by a large banking

sector. The big four state-owned banks, comprising the Industrial

and Commercial Bank of China (ICBC), Agricultural Bank of China

(ABC), Bank of China (BOC), and China Construction Bank (CCB),

account for more than two-thirds of total deposits and loans in

China.4 At the end of 2009, the big four banks had deposits of

30.06 trillion RMB and loans of 17.32 trillion RMB, while the other

13 joint-stock commercial banks had deposits of 10.95 trillionRMB and loans of 8.19 trillion RMB (Peoples Bank of China, 2010).

2 Only a few studies investigate the influence of financial deepening at the micro

level, such as the way in which financing development affects firm growth and

investment (Demirg-Kunt and Maksimovic, 1998; Beck et al., 2004).3 Among the determinants of cash holdings examined in the literature, the term

most closely related to trade credit is net working capital, which is regarded as a

liquidity substitute. Net trade credit (accounts receivable minus accounts payable) is

just one component of net working capital (Opler et al., 1999; Dittmar and Mahrt-

Smith, 2007).4 In the mid-1990s, the Chinese Government promulgated the Commercial Bank

Law and established three policy banks to take over the policy-related lending of

the above big four banks. Thus, the big four banks were commercialized. In addition

to the big four banks, there are another 13 joint-stock commercial banks such as the

Bank of Communications, China CITIC Bank, Shenzhen Development Bank, and China

Merchants Bank. Other than these 17 banks, there were 143 city commercial banks,

43 rural commercial banks, and 196 rural cooperative banks in China at the end of2009 (China Banking Regulatory Commission, 2010).

W. Wu et al. / Journal of Banking & Finance 36 (2012) 28682883 2869


3/16

The main source of external financing in China is loans from the

banking sector. From 1990 to 2008, the average annual ratio of total

bank loans to GDP was 82.4%.

Following the establishment of the Shanghai and Shenzhen

stock exchanges in 1990 and 1991, respectively, Chinas stock mar-

ket has grown at a remarkable rate. At the end of 2010, 2063 firms

were listed on the two exchanges with a total market value of 4

trillion USD, which is equivalent to 66.7% of Chinas GDP (ChinaSecurities Regulatory Commission, 2011). However, the funds

raised on the stock market are trivial in comparison with the

amount provided in bank loans. From 1990 to 2008, the average

annual ratio of total funds raised from the equity market to GDP

was only 0.81%. During this time, the corporate bond market

lagged behind the development of the equity market. The average

annual ratio of total funds raised from the corporate bond market

to GDP was only 0.76% between 1990 and 2008.

Fig.1 illustrates the ratio of total bank loans to GDP and the ratio

of total funds raised from the equity and corporate bond markets to

GDP from 1990 to 2008. The ratio of bank loans to GDP ratio can be

seen to fluctuate dramatically over the period, rising from a low of

61.6% in 1995 to a peak of 108% in 2003. The ratio of funds raised

from securities markets to GDP also fluctuated over time, climbing

from less than one half of a percent in 1990 to 5% in 2007. Compar-

ing the two ratios, the banking sector clearly dominates the securi-

ties markets, with total bank loans amounting to around 75 times

the amount of funds raised from the securities markets.

2.2. Use of trade credit in Chinese firms

In addition to securing funding through banks and securities

markets, Chinese firms can also access finance through trade credit

(Ge and Qiu, 2007; Cull et al., 2009). Several studies document that

Chinese firms use and offer trade credit much like firms in devel-

oped countries. Using data from a survey conducted by the Chinese

Academy of Social Sciences (CASS) in 2000,Ge and Qiu (2007)re-

port that the averages of accounts receivable and accounts payable

in their sample represent 13% and 14% of firms total assets, respec-

tively, while the ratios of accounts receivable and payable to total

sales are 27% and 23%, respectively.Cull et al. (2009)show a sim-

ilar ratio of accounts receivable to total sales using a large sample

of more than 100,000 large and medium-sized industrial firms

from 1998 to 2003. Even listed firms, which may find it easier gain-

ing access to finance, tend to use and extend as much trade credit

as unlisted firms. Based on a sample of non-financial listed firms

from 1999 to 2009, we find that the ratios of accounts receivable

and payable to total assets are 14.5% and 10.9%, respectively, while

the ratios of accounts receivable and payable to total sales are 34%

and 20%, respectively.

Studies have also compared SOEs and non-SOEs in China

according to how they use and offer trade credit. Cull et al.

(2009) document that the ratio of trade credit extended to total

sales for SOEs is 36.5%, twice that of domestic private firms

(18%). However,Ge and Qiu (2007) find that non-SOEs use more

trade credit than SOEs.

2.3. The new receivables pledge policy since 2007

Before the China Property Rights Law was enacted in 2007, se-

cured transactions in China were regulated by a variety of laws.

The General Principles of Civil Law, the Security Law, and the Land

Administration Law dealt separately with various aspects of prop-

erty ownership. This not only created confusion, but also increased

the number of bureaucratic procedures that applied, making the

process of creating, registering and enforcing security interests

costly, time-consuming and uncertain.

Furthermore, before 2007, non-possessory security interests in

China were allowed only for equipment and motor vehicles under

Article 34 of the 1995 Security Law. This meant that trade receiv-

ables, as one class of movable property, could not be used as collat-

eral. According to a joint report by the World Bank and the PeoplesBank of China, only 4% of Chinas commercial loans were financed

by movable assets (FIAS/IFC, 2007).

Chinas new Property Rights Law was passed on March 16, 2007

and came into effect on October 1 of that year. The new Property

Rights Law merged all of the laws that previously regulated se-

cured transactions under a uniform code. More importantly, under

Article 223 of the new law, trade receivables constitute a form of

property right that can be pledged. This means that trade receiv-

ables can be used as collateral to secure loans.

In accordance with the Property Rights Law, in 2007 Chinas

central bank promulgated the Measures for the Registration of

Pledge Receivables, which set out the detailed implementation

rules for using trade receivables as collateral to secure loans.

At the same time, Chinas central bank set up an electronicregistration and public notice system to facilitate the registration

process. According to the Credit Reference Center of the Peoples

Bank of China, more than 2 trillion RMB in loans were secured

against receivables by small and medium-sized enterprises

between October 2007 and September 2009 (Peoples Bank of

China, 2009).

3. Hypothesis development

3.1. Trade credit and cash holdings

3.1.1. Theories explaining cash holdings

Previous studies have found that cash and cash equiva-

lents comprise a large percentage of firms assets. Dittmar andMahrt-Smith (2007)find that the sum of all cash and marketable

securities represented more than 11% of the total assets of large

publicly traded US firms in 2003. Ozkan and Ozkan (2004) show

that in the United Kingdom, the average ratio of cash and

equivalent items to total assets was 10.3% between 1984 and

1999. Similar patterns have been identified in other countries.

For example, the cash ratios in Japan, Germany, and France are

17%, 9%, and 12%, respectively (Guney et al., 2007).

Several studies have attempted to explain why firms hold so

much cash, as the returns associated with cash are lower than

those for productive investment. Bates et al. (2009) list four

reasons firms hold more cash: the agency motive, the transaction

motive, the precautionary motive, and the tax motive. The agency

motive reflects the argument that managers keep more freecash flow in firms for their own private benefit, such as empire

0.6

0.7

0.8

0.9

1

1.1

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Year

Loan/GDP

0

0.01

0.02

0.03

0.04

0.05

Markets/GDP

Loan Markets

Fig. 1. Bank loans ratio and funds raised from securities markets ratio, 19902008.

The bank loans ratio (loans/GDP) is calculated as total bank loans divided by the

GDP of China for the year. The ratio of funds raised from securities markets

(markets/GDP) is calculated as the sum of funds raised from the stock market andcorporate bonds divided by the GDP in that year.

2870 W. Wu et al. / Journal of Banking & Finance 36 (2012) 28682883


4/16

building or the consumption of more discretionary perquisites

(Dittmar et al., 2003; Guney et al., 2007; Harford et al., 2008).

The transaction cost motive suggests that firms hold cash because

converting assets into cash entails transaction costs (Opler et al.,

1999). The precautionary motive asserts that firms hold cash to

avoid future shortages of cash for investment, because raising

external finance is more costly than using internally generated

funds in the presence of asymmetric information (Opler et al.,1999).5

3.1.2. Trade credit and cash holdings

The advantage of using trade credit is that the buyer need not

pay for goods on delivery and can enjoy a short deferment period

before payment is due. The seller of the goods extends credit to

the buyer, who is not required to deliver cash to the seller during

the period for which credit is extended. Thus, trade credit can be

regarded as a short-term financing instrument. Outstanding ac-

counts payable can create costs when cash is short. There is an

opportunity cost if a firm forgoes a cash discount and instead pays

the bill on the final due date of the net period. If a firm postpones

payment beyond the net period due to a cash shortage, it will in-

cur one of several possible costs of stretching accounts payable,including late payment penalties or interest, a possible deteriora-

tion in its credit rating, and the cost of the cash discount forgone,

if any. Consequently, from the perspective of the precautionary

motive, firms that use trade credit must hold some additional

cash to meet their repayment obligations under the arrangements

for that credit to enjoy a cash discount and avoid late payment

penalties.

When a supplier offers trade credit, it does not receive cash at

the time it delivers the goods or services to the buyer. Rather,

the cash owing becomes an account or note receivable on the bal-

ance sheet. However, the supplier expects to collect cash from

these receivables at some point in the future, or can factor them

(use them as collateral for finance from a bank). These receivables

can thus be regarded as a cash substitute. This means that creditreceivables decrease cash holdings, in that the more receivables a

firm has, the less cash it holds.

3.1.3. Asymmetric effect of payables and receivables on cash holdings

Firms usually grant and receive trade credit at the same

time. As receivables can be regarded as a cash substitute, they

can be used to cover payables. This means that firms can hold

less cash to meet their payable obligations when they have

receivables on the balance sheet. However, risk aversion means

that $1 of receivables does not usually cover $1 of payables.

There is uncertainty about collecting receivables on time, and

firms are not always successful in collecting all receivables in

full. Some receivables are treated as bad debt losses over time.

Hence, receivables are discounted as a cash substitute, and arenot perfect substitutes for cash. Cash provides unconditional

liquidity for firms, whereas receivables are less liquid and subject

to credit risk.

Firms incur many costs associated with the late payment of

payables. Some firms prefer to pay payables earlier to obtain a dis-

count. To guarantee their operations, firms generally hold enough

cash to cover their payables. If a firm uses receivables rather than

cash to pay its payables, then its creditors will ask for receivables

with a face value higher than the cash amount owed. Thus, from

the cash holding perspective, payables and receivables have an

asymmetric effect on cash holdings in that $1 of receivables does

not cover $1 of payables.

3.2. Financial deepening and the relationship between trade credit and

cash holdings

Although firms hold additional cash to cover their trade pay-

ables, the amount of cash they hold will not be the same as

the value of their payables. This is because cash, as a liquid asset,

has a lower rate of return due to the liquidity premium. Previous

studies have found that the value of $1 of cash is less than $1(Dittmar and Mahrt-Smith, 2007). As a result, firms hold as little

cash as possible. The optimal amount of additional cash held to

repay trade credit reflects a tradeoff between the lower rate of

return on cash and the cost of a cash shortage in paying for

credit.

We argue that the development of the financial sector can

influence the cost of cash shortages and thus has an impact on

the relationship between payables and cash holdings. A high le-

vel of financial deepening provides the industrial sector with bet-

ter financial services, including easier access to finance, shorter

processing times to obtain funds, and lower financing costs.

These benefits help firms to reduce the cost of cash shortages

in paying for credit. Firms in regions with higher levels of finan-

cial deepening are thus likely to hold less cash to cover their

trade payables.

In a more developed financial sector, financial intermediaries,

particularly banks, are better able to identify and pool the credit

risk of receivables and thus reduce the transaction costs incurred

in factoring receivables or using receivables to secure loans. The

better financial services available in more developed financial sec-

tors lessen the costs incurred by firms in converting their receiv-

ables into cash. Hence, firms in regions with higher levels of

financial deepening can substitute more of their receivables for

cash. Based on this discussion, we present the following

hypothesis.

Hypothesis 1. Firms in regions with higher levels of financial

deepening hold less cash for payables. Firms in regions with higher

levels of financial deepening can substitute more of their tradereceivables for cash.

3.3. Influence of the new receivables pledge policy on the sensitivity of

cash holdings to trade credit

Trade receivables are an important part of firms overall assets,

representing 14.5% of the total assets of Chinese non-financial

listed firms from 1999 to 2009. Before the new Property Law came

into effect in China in 2007, trade receivables could not be used as

collateral for securing loans. This affected the liquidity of receiv-

ables, which were classified as a liquid asset. Consequently, the

ability to convert receivables into cash was greatly reduced when

firms faced cash shortages. In other words, the substitute ratio of

receivables for cash was low.

However, Chinas new Property Rights Law allows trade receiv-

ables to be used as collateral to secure loans. According to the new

law, firms can factor their receivables when they face a cash short-

age. This will enhance the short-term financing function of trade

receivables. We thus predict that the new receivables pledge policy

has increased the substitute ratio of trade receivables for cash.

However, as this new policy has nothing to do with trade payables,

it does not affect the relationship between payables and cash hold-

ings. We present the hypothesis as follows.

Hypothesis 2. The substitute ratio of trade receivables for cash has

increased since the new receivables pledge policy came into force

in 2007. The new receivables pledge policy does not affect the

sensitivity of cash holdings to trade payables.5 The tax motive theory argues that US firms that incur tax costs associated withrepatriating foreign earnings hold more cash (Foley et al., 2007).



5/16

4. Research design

4.1. Data and sample

Our data are taken from the China Stock Market and Accounting

Research (CSMAR) database. We start with a sample of 1729 firms

and 14,313 firm-year observations from 1999 to 2009 for non-

financial A-share listed firms in China. After deleting any firm-yearobservations with missing data or with either zero or negative total

assets or sales, our final sample is reduced to 1626 firms and

13,229 firm-year observations.

4.2. Measurement of the key variables

4.2.1. Cash holding level

Following previous studies (Opler et al., 1999; Dittmar et al.,

2003; Dittmar and Mahrt-Smith, 2007), we define the cash ratio

as the ratio of cash and cash equivalents to net assets, where net

assets are computed as total assets less cash and cash equivalents.

4.2.2. Trade credit

On the balance sheets of Chinese listed firms, accounts receiv-

able and notes receivable are terms that describe situations in

which suppliers extend trade credit, whereas accounts payable

and notes payable are terms that describe situations in which cus-

tomers receive trade credit. The variables CRDT_REVand CRDT_PAY

are respectively defined as the sum of accounts receivable and

notes receivable and the sum of accounts payable and notes pay-

able, deflated by net assets.6

4.2.3. Financial deepening

As discussed in Section2.1, bank loans are the major source of

enterprise finance in China. Therefore, we use the ratio of total

bank loans to the GDP of the province in which the firm is located

to measure financial deepening. Bank loan data are obtained from

the relevant annual issues of the Almanac of Chinas Finance and

Banking (ACFB). GDP data are taken from the relevant annual is-

sues of the China Statistical Yearbook.Appendix Ashows the aver-

age financial deepening ratio from 1998 to 2008 by province.

4.3. Regression model and control variables

We extend the analysis of Opler et al. (1999) to trade credit

receivables and payables and use the following regression model

to calculate their influence on cash holdings.

CASHi;t a b1TRADECREDITi;t b2LIQUIDi;t b3SIZEi;t1 b4LEVi;t1 b5DEBTMi;t1 b6M=Bi;t1 b7CAPEXi;t1

b8CASHFLOWi;t1 b9DIVIDENDi;t1 b10TOP1i;t1

b11STATEi;t1 b12DEEPENi;t1 INDUSTRY; YEAR and PROVINCE Dummiesi;t1 ei;t

1

The dependent variable, CASH, isfirm is cash holding ratio at time t.

The independent variables include trade credit variables and several

control variables. Based on prior studies (Opler et al., 1999; Dittmar

and Mahrt-Smith, 2007), we include the control variables of net

working capital ratio (LIQUID), firm size (SIZE), financial leverage

(LEV), debt maturity (DEBTM), market-to-book ratio (M/B), capital

expenditure (CAPEX), cash flow (CASHFLOW), a dividend dummy

(DIVIDEND), the stake of the largest shareholder (TOP1), a state-

owned enterprise dummy (STATE), and the financial deepening

measure (DEEPEN). Except for the trade credit and net working cap-

ital variables, the other control variables are all calculated at the

beginning of the year to mitigate endogeneity problems. The defini-

tions of these variables are discussed in the following section and

are summarized inTable 1.

The net working capital ratio (LIQUID) is a proxy for liquid as-

sets and is defined as the ratio of net working capital (working cap-

ital minus cash and cash equivalents) to net assets. Net working

capital can be seen as a substitute for cash holdings, because firms

can use their liquid assets when they experience cash shortfalls.

There is a negative association between a firms cash holdings

and its liquid assets. Additionally, net trade credit (the sum of ac-

counts and notes receivable minus the sum of accounts and notes

payable) is just one component of net working capital. To avoid

duplication in measuring trade credit, we also use an alternative

liquidity measure, LIQUID2, defined as the ratio of net working cap-

ital minus net trade credit to net assets.

Firm size (SIZE), defined as the natural logarithm of assets, is

known to be negatively associated with cash holdings. Larger firms

hold less cash, as they are more likely to be diversified and thus

less likely to experience financial distress. They also face fewer

borrowing constraints and lower external financing costs (Opler

et al., 1999; Dittmar et al., 2003). Leverage (LEV, total debt to total

assets) also exerts a negative impact on cash holdings, as higher

leverage indicates better access to external funds and reduces the

free cash flow problem (Opler et al., 1999; Harford et al., 2008).

Debt maturity (DEBTM, long-term debt to total debt) is related to

liquidity risk. We expect debt maturity to be positively associated

with cash holdings, as firms with longer maturity debt will hold

more liquidity in case they cannot meet fixed debt payments dur-

ing economic recessions (Morris, 1992)

We use the market-to-book ratio (M/B) to proxy for growth

opportunities.M/B is defined as the ratio of the book value of total

assets minus the book value of equity plus the market value of

equity to the book value of assets.7 Previous studies have found that

firms with more growth opportunities hold more cash (Opler et al.,

1999; Dittmar et al., 2003).Findings on the influence of the ratio of capital expenditure to

net assets (CAPEX) on cash holdings are mixed. Opler et al.

(1999)find a positive impact of capital expenditure on cash hold-

ings, whereas Harford et al. (2008) find a negative relationship. The

cash flow ratio (CASHFLOW) is defined as net cash flow from oper-

ations divided by net assets. Opler et al. (1999) andHarford et al.

(2008)find that firms with larger cash flows are associated with

larger cash holdings, whereasOzkan and Ozkan (2004) identify a

negative impact of cash flow on cash holdings. The dividend

dummy (DIVIDEND) equals one in years in which a firm paid a cash

dividend and zero otherwise. Findings on the impact of dividend

payouts on cash holdings are also mixed. Opler et al. (1999),

Dittmar et al. (2003), and Harford et al. (2008) find a negative

relationship, whereasOzkan and Ozkan (2004) document a posi-tive relationship.

In addition to these financial control variables, we also include

several ownership structure variables.8 TOP1 is the percentage of

6 We also use total assets and total sales (or the cost of goods sold) as the deflator,but our results remain similar.

7 We take into account the special split share structure in China whereby some

shares are non-tradable on the stock market. We set the market value of non-tradable

shares as their book value, because these shares are usually transferred at a price

benchmarked against their book value. Thus, M/B is calculated as the ratio of the

number of tradable shares multiplied by the market price plus the number of non-

tradable shares multiplied by the book value of equity per share plus the book value

of total debt to the book value of total assets. We also use the standard calculation of

M/B as a robustness check, but our conclusions remain the same.8 In our sample, the average percentage of shares held by the CEO is only 0.1%. As

management ownership in China is negligible, we do not include a management

ownership variable in our models. We rerun the regressions including the percentageof CEO shares and find that the results remain qualitatively the same.



6/16

shares held by the largest shareholder.9 STATE is a dummy that

equals one if the firm is ultimately controlled by the governmentand zero otherwise.10 Industry and year dummy variables are

included in the model to account for time-invariant industry heter-

ogeneity and time trends. Industry classification is based on that of

the China Securities Regulatory Commission (CSRC), which recog-

nizes 21 industries, with a one-digit code for non-manufacturing

industries and a two-digit code for manufacturing industries. A prov-

ince dummy is added to capture differences in economic develop-

ment, legal institutions (enforcement and judicial efficiency), and

corruption across regions.

4.4. Regression method

We derive our main results using ordinary least squares (OLS)

regression. However, there is possible endogeneity between tradecredit and cash holdings, as a firms cash policy may have an im-

pact on its trade credit policies. We thus conduct a two-stage

instrumental variables regression to correct for this endogeneity

problem. The first stage of the procedure involves an OLS analysis

in which trade payables (or receivables) are regressed against the

same controls used for the OLS regressions and panel analyses plus

four other variables known to affect trade credit. These variables

are fixed assets to total assets, the natural logarithm of firm age

in years (Petersen and Rajan, 1997; Giannetti et al., 2011), the

lagged cash holding ratio, and a dummy that indicates whether

the firm has engaged in related-party trade in that year. The esti-

mate of trade payables (receivables) generated in the first stage

is then included in the second-stage regression in which the

dependent variable is the cash holdings measure.

5. Empirical results

5.1. Descriptive statistics

Table 2presents the descriptive statistics for the variables. We

winsorize the financial variables at the 1% level to mitigate the

effect of outliers.11 The mean value ofCASHis 21.1%, from which we

calculate the ratio of cash and cash equivalents to total assets to be17.4%. This suggests that listed firms in China hold as much cash as

firms in other countries. The ratio of trade credit payable (the sum of

accounts and notes payables) to net assets is 13.2%. This indicates

that in common with firms in other countries, Chinese listed firms

take a large amount of trade credit. The ratio of trade credit receiv-

able (the sum of accounts and notes receivable) is 17.5%, which is

higher than the ratio of payables to net assets. This suggests that

listed firms extend more trade credit to customers than they receive

from suppliers.

We report a correlation analysis of the variables inTable 3. The

table shows that, except for correlations between LIQUID andLI-

QUID2, the correlations between the variables are not very high.

We also check the variance inflation factors (VIFs) of the coeffi-

cients in our models and find that they are less than 10. This sug-gests that multicollinearity is not a serious concern.

5.2. Asymmetric impact of trade payables and receivables on cash

holdings

Table 4presents the results of multivariate regressions on the

relationship between trade credit and cash holdings. Panel A ofTa-

ble 4reports the results of the four regression models, and Panel B

reports the results of the tests of equality of the coefficients. LIQUID

and LIQUID2 (excluding the trade credit terms) are included in

Models (1) and (2), respectively, to proxy for substitute liquidity.

Model (3) separatesLIQUIDinto two terms:LIQUID2and net trade

credit extended (trade receivables minus trade payables). We in-

clude the trade credit variables in Model (4) to estimate the influ-ence of trade credit on cash holdings. The constant term, industry,

year, and province dummies are included in all of the regressions,

although the results are not reported for brevity. The p-values in

the panel regressions are based on standard errors corrected for

the clustering of firms (Petersen, 2009).

First, we compare the influence of liquidity assets on cash hold-

ings in Models (1)(3). The three measures ofLIQUID,LIQUID2, and

the difference between LIQUID and LIQUID2 are negative and signif-

icant at less than the 1% significance level. The signs and signifi-

cance levels of the other variables in Model (3) are the same as

those in Model (1). This suggests that replacingLIQUID with LI-

QUID2 does not affect the impact of the other variables on cash

Table 1

Definitions of the variables.

Code Definition

CASH The ratio of cash and cash equivalents to net assets, where net assets are computed as total assets less cash and cash equivalents

CRDT_PAY The sum of accounts payable and notes payable, deflated by net assets

CRDT_REV The sum of accounts receivable and notes receivable, deflated by net assets

LIQUID The ratio of net working capital (working capital minus cash and cash equivalents) to net assets

LIQUID2 The ratio of net working capital minus net trade credit to net assets, where net trade credit is defined as the sum of accounts receivable and notes

receivable minus the sum of accounts payable and notes payableSIZE Firm size, calculated as the natural log of total assets

LEV Financial leverage, calculated as total debt divided by total assets

DEBTM The ratio of long-term debt to total debt

M/B The ratio of the book value of total assets minus the book value of equity plus the market value of equity to the book value of assets

CAPEX Capital expenditure, calculated as capital expenditure divided by total sales

CASHFLOW The ratio of net cash flow from operations to net assets

DIVIDEND A dummy that equals one for years in which the firm paid a cash dividend and zero otherwise

TOP1 The percentage of shares held by the largest shareholder

STATE A dummy variable that equals one if the firm is ultimately controlled by the government and zero otherwise

DEEPEN The ratio of bank loans to GDP in the province in which the firm is located

POLICY A dummy variable that equals one if the year is after 2007 and zero otherwise

DRPT_BUY A dummy variable that equals one if the firm has engaged in a related-party trade as a buyer in the year, and zero otherwise

DRPT_SELL A dummy variable that equals one if the firm has engaged in a related-party trade as the seller in the year, and zero otherwise

9 We report only the results for the model without the square term of TOP1. When

we include the square term ofTOP1in the regression model, it is not significant and

our conclusions do not change.10 We adopt the ownership classification scheme based on the identity of the

ultimate owner used in recent studies of Chinese listed firms ( Wu et al., forthcoming).

State firms are ultimately controlled by the central and local governments or an

associated entity, such as central and local state-owned asset management bureaus,the Ministry of Finance, or local finance bureaus.

11 We also perform a robustness check without winsorizing the variables. Theresults remain qualitatively similar.



7/16

holdings. However, as shown in Model (3), the coefficient of LI-

QUID2 is 0.28 and its absolute magnitude is lower than that of

the coefficient of net trade credit extended (LIQUIDLIQUID2),

which is 0.32. The results of the equality tests reported in Panel

B also show that these two coefficients are statistically different,

which suggests that the impact of net trade credit is different from

that of the other components of net working capital. This implies

that it is necessary to separate trade credit terms from net working

capital when considering their impact on cash holdings.

In Model (4), we include CRDT_PAYand CRDT_REV to investigate

their individual influence on cash holdings. The coefficient of

CRDT_PAY is 0.71 and is statistically significant. Because the

denominators of the CRDT_PAYandCASHratios are the same, the

coefficient of CRDT_PAYof 0.71 indicates that firms hold an addi-

tional $0.71 of cash for every $1 of trade credit payable. The results

of the equality tests documented in Panel B show that the coeffi-cient value of $0.71 is significantly less than 1. This suggests that

firms do not hold the same amount of cash for the precautionary

repayment of trade credit.

The coefficient of CRDT_REV is statistically significantly nega-

tive. This indicates that firms treat receivables as cash substitutes

and reduce their cash holdings accordingly. However, the coeffi-

cient is only 0.15. This means that $1 of trade credit receivable

substitutes for only $0.15 of cash, which is far less than the $0.71

of cash needed for every $1 of trade credit payable. The results of

the tests on the equality of the coefficients in Panel B show that

the sum of these two coefficients is significantly different from

zero. This clearly demonstrates that $1 of receivables is not equiv-

alent to $1 of payables in terms of cash holdings.

In an unreported regression, we replicate Table 4 using theFamaMacBeth model. A cross-sectional regression is estimated

to eliminate the problem of serial correlation in the residuals of a

time-series cross-sectional regression. The results remain un-

changed, lending additional support for the asymmetric impact

of credit payable and receivable on cash holdings and suggesting

that firms with zero net trade credit still need to hold some cash

for payables. However, if we treat trade credit terms merely as

components of working capital, as is the standard approach in

the literature, we might mistakenly conclude that no cash is

needed for zero net trade credit, as receivables cover payables.

Clearly, it is essential to treat trade credit payable and trade credit

receivable differently when investigating their respective impact

on cash holdings.

Table 4shows that firm size (SIZE), financial leverage (LEV), andcapital expenditure (CAPEX) are negatively associated with cash

holdings. This indicates that firms that are smaller and have lower

financial leverage and less capital expenditure have larger cash

holdings. The coefficient ofDEBTMis significantly positive, which

suggests that firms with longer-term debt hold more cash to avoid

the risk of unexpected liquidity problems (Morris, 1992). The sig-

nificantly positive coefficient ofCASHFLOW indicates that firms

with more net cash flow from operations hold more cash ( Opler

et al., 1999; Dittmar et al., 2003). The coefficient ofDIVIDEND is sig-

nificantly positive, which is consistent with the finding ofOzkan

and Ozkan (2004) that dividend-paying firms hold more cash to

avoid running out of funds to meet their dividend payments. In

terms of ownership characteristics,TOP1is insignificant. This indi-

cates that the two conflicting forces exerted by largest block own-

ership on cash holdings may cancel each other out. The coefficient

of STATE in Model (4) is significantly negative, suggesting that

state-owned enterprises hold less cash due to their advantages inobtaining financing. The coefficients of the financial deepening var-

iable are also insignificant.

5.3. Financial deepening and the relation between trade credit and

cash holdings

Table 5reports the results of the regression of the impact of

financial deepening on the relationship between trade credit

and cash holdings. Models (1) and (2) present the results for

the subsamples based on financial deepening. Model (1) shows

the results for the subsample with a lower level of financial deep-

ening and Model (2) those for the subsample with a higher level

of financial deepening. Models (3) and (4) present the results of

the regression of the interaction terms between the financialdeepening variable and credit payables and credit receivables,

respectively. Model (5) includes the interaction terms of the

financial deepening variable with credit payables and credit

receivables.

As shown in Model (1) ofTable 5, for the subsample with a low-

er level of financial deepening, the coefficient ofCRDT_PAYis 0.720,

whereas that in Model (2) for the subsample with a higher level of

financial deepening is 0.709. This suggests that firms located in re-

gions with greater financial depth hold less precautionary cash for

payables. As greater financial depth enables firms to borrow from

banks, it reduces the probability that they will experience a cash

shortage when paying off their payables. The coefficient of

CRDT_REV in Model (1) is 0.138, whereas in Model (2) it is

0.199. This shows that the substitute ratio of receivables for cashin firms in regions with a higher level of financial deepening is

Table 2

Descriptive Statistics for the Main Variables.

Variable N Mean Standard deviation Min P25 Median P75 Max

CASH 13,229 0.211 0.223 0.003 0.077 0.146 0.264 1.718

CRDT_PAY 13,229 0.132 0.116 0.000 0.048 0.099 0.180 0.575

CRDT_REV 13,229 0.175 0.136 0.001 0.065 0.148 0.253 0.612

LIQUID 13,229 0.088 0.293 1.512 0.216 0.063 0.085 0.503

LIQUID2 13,229 0.131 0.285 1.528 0.245 0.107 0.023 0.493

SIZE 13,229 21.063 1.143 10.391 20.356 20.960 21.693 27.940LEV 13,229 0.521 0.281 0.074 0.359 0.500 0.633 2.160

DEBTM 13,229 0.146 0.174 0 0.010 0.077 0.222 0.726

M/B 13,229 1.555 0.655 0.950 1.140 1.340 1.713 4.821

CAPEX 13,229 0.059 0.061 0.000 0.013 0.039 0.082 0.296

CASHFLOW 13,229 0.068 0.117 0.488 0.038 0.070 0.115 0.464

DIVIDEND 13,229 0.507 0.500 0 0 1 1 1

TOP1 13,229 0.398 0.167 0.004 0.266 0.378 0.526 0.886

STATE 13,229 0.687 0.464 0 0 1 1 1

DEEPEN 13,229 1.010 0.369 0.447 0.773 0.878 1.172 2.176

DRPT_BUY 13,229 0.453 0.498 0 0 0 1 1

DRPT_SELL 13,229 0.474 0.499 0 0 0 1 1

This table presents the summary statistics for the variables. The definitions of the variables are as presented in Table 1.



8/16

Table 3

Pearson correlation matrix for the variables.

Variable CASH CRDT_PAY CRDT_REV LIQUID LIQUID2 SIZE LEV DEBTM M /B CAPEX CASHFL

CRDT_PAY 0.139***

(0.001)

CRDT_REV 0.048*** 0.275***

(0.001) (0.001)

LIQUID 0.001 0.170*** 0.204***

(0.901) (0.001) (0.001)

LIQUID2 0.046*** 0.102*** 0.147*** 0.855***

(0.001) (0.001) (0.001) (0.001)

SIZE 0.184*** 0.096*** 0.222*** 0.066*** 0.214***

(0.001) (0.001) (0.001) (0.001) (0.001)

LEV 0.266*** 0.242*** 0.063*** 0.692*** 0.649*** 0.038***

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

DEBTM 0.159*** 0.281*** 0.284*** 0.032*** 0.052*** 0.296*** 0.125***

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

M/B 0.118*** 0.101*** 0.030*** 0.047*** 0.111*** 0.387*** 0.049*** 0.081***

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

CAPEX 0.041*** 0.097*** 0.234*** 0.027*** 0.046*** 0.187*** 0.158*** 0.255*** 0.012

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.160)

CASHFLOW 0.339*** 0.039*** 0.161*** 0.265*** 0.331*** 0.157*** 0.482*** 0.016* 0.054*** 0.239***

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.072) (0.001) (0.001)

DIVIDEND 0.175*** 0.025*** 0.140*** 0.138*** 0.221*** 0.292*** 0.251*** 0.093*** 0.081*** 0.270*** 0.341*

(0.001) (0.004) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

TOP1 0.028*** 0.008 0.007 0.115*** 0.114*** 0.206*** 0.159*** 0.044*** 0.149*** 0.094*** 0.164*

(0.001) (0.334) (0.424) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

STATE 0.036*** 0.005 0.060*** 0.020** 0.052*** 0.238*** 0.094*** 0.090*** 0.143*** 0.045*** 0.066*

(0.001) (0.542) (0.001) (0.018) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

DEEPEN 0.124*** 0.021** 0.005 0.036*** 0.026*** 0.064*** 0.033*** 0.028*** 0.002 0.035*** 0.022*

(0.001) (0.014) (0.587) (0.001) (0.002) (0.001) (0.001) (0.001) (0.799) (0.001) (0.010)

This table reports the Pearson correlation matrix for the variables. The p-values are presented in parentheses below the correlation coefficients, where the definitions of the va* Significance at the 10% level.

** Significance at the 5% level.*** Significance at the 1% level.


9/16

higher than that in firms in regions with less financial depth. These

results are consistent with our first hypothesis.

To test whether the coefficient of trade credit differs acrossfirms located in regions with different levels of financial depth,

we include the interaction terms between the financial deepening

variable (DEEPEN) and the trade credit variables in the model. The

columns for Models (3)(5) in Table 5report the results. The inter-

action terms betweenDEEPENandCRDT_PAYare significantly neg-

ative in Models (3) and (4), whereas those between DEEPENand

CRDT_REVare both significantly negative across Models (4) and

(5). This supports our first hypothesis, that is, financial deepening

helps firms to reduce cash holdings for payables and to increase

the substitute ratio of receivables for cash.

Overall, these results suggest that firms in regions with higher

levels of financial deepening are less likely to experience cash

shortages. Financial depth reduces the cost of a shortage of cash

to repay credit and increases the substitute ratio of receivablesfor cash. Financial deepening thus negatively affects both the

relationship between cash holdings and credit payables and that

between cash holdings and receivables.

5.4. Influence of the new receivables pledge policy

Table 6 reports the results for the regression of the impact of the

new receivables pledge policy on the relationship between trade

credit and cash holdings. We divide the full sample into two subs-amples comprising pre- and post-2007 observations, respectively,

as the receivables pledge policy was implemented in 2007. Model

(1) presents the results for the pre-2007 subsample and Model (2)

those for the post-2007 subsample. To test the statistical signifi-

cance of the impact of the receivables pledge policy, we include

the interaction term between the trade credit variables and a 1-

year dummy variable (POLICY) that takes the value of one if the

observation is after 2007, and zero otherwise. The Model (3)(5)

columns report the results of the regressions with the interaction

terms.

In comparing the coefficients of CRDT_PAY and CRDT_REV be-

tween Model (1) and Model (2) inTable 6, we find that the coeffi-

cient of CRDT_PAY decreases a little after implementation of the

new receivables pledge policy, whereas the coefficient ofCRDT_REV

decreases substantially after 2007, falling from 0.155 to 0.203.

This suggests that the new policy has substantially increased the

substitute ratio of receivables for cash, as it officially allows firms

to use receivables as collateral to borrow from banks.12 However,

as the new policy has nothing to do with payables, it does not signif-

icantly affect firms cash holdings for payables. These results are con-

sistent with our second hypothesis.

Model (5) of Table 6, which includes both of the interaction

terms betweenCRDT_PAYandCRDT_REVand the policy year dum-

my (POLICY), may be better specified than Models (3) and (4),

which have only a single interaction term. Therefore, we mainly

derive our conclusion from the results of Model (5). In Model (5),

the coefficient of the interaction term between CRDT_PAYand POL-

ICYis insignificant, whereas that of the interaction term between

CRDT_REVand POLICYis significantly negative. These results sup-port our second hypothesis, that is, the new receivables pledge pol-

icy helps firms to increase the substitute ratio of receivables for

cash, but has no significant influence on the relationship between

credit payables and cash holdings. Given that the policy represents

a deepening of the financing environment, our finding also sup-

ports the view that financial deepening has a positive impact on

the use of trade receivables as a cash substitute.13

Furthermore, we compare the influence of the policy on firms

located in regions with different levels of financial deepening. As

shown in Models (1) and (2) ofTable 7, the coefficient of the inter-

action term between CRDT_PAY and DEEPEN decreases from

0.055 to 0.080 after implementation of the new receivables

pledge policy, whereas the coefficient of the interaction term be-

tween CRDT_REV and DEEPENdecreases substantially after 2007,falling from 0.007 to 0.125. This suggests that the new receiv-

ables pledge policy has had a stronger impact on firms in regions

with higher levels of financial deepening. This is a reasonable

Table 4

Multivariate regression of the impact of trade credit on cash holdings.

Model 1 Model 2 Model 3 Model 4

Panel A: Regression results

LIQUID 0.319***

(0.000)

LIQUID2 0.201*** 0.284*** 0.360***

(0.000) (0.000) (0.000)

LIQUIDLIQUID2 0.320***

(0.000)

SIZE 0.046*** 0.044*** 0.047*** 0.048***

(0.000) (0.000) (0.000) (0.000)

LEV 0.350*** 0.232*** 0.327*** 0.438***

(0.000) (0.000) (0.000) (0.000)

DEBTM 0.078*** 0.021* 0.067*** 0.188***

(0.000) (0.059) (0.000) (0.000)

M/B 0.007** 0.012*** 0.007** 0.001

(0.041) (0.000) (0.029) (0.704)

CAPEX 0.521*** 0.384*** 0.507*** 0.466***

(0.000) (0.000) (0.000) (0.000)

CASHFLOW 0.535*** 0.593*** 0.530*** 0.510***

(0.000) (0.000) (0.000) (0.000)

DIVIDEND 0.054*** 0.057*** 0.054*** 0.052***

(0.000) (0.000) (0.000) (0.000)

TOP1 0.013 0.012 0.011 0.010

(0.220) (0.268) (0.297) (0.367)STATE 0.007* 0.000 0.006 0.007**

(0.079) (0.927) (0.118) (0.046)

DEEPEN 0.031* 0.021 0.030* 0.019

(0.068) (0.167) (0.075) (0.205)

CRDT_PAY 0.714***

(0.000)

CRDT_REV 0.153***

(0.000)

Sample size 13,229 13,229 13,229 13,229

Adj-R2 0.349 0.310 0.338 0.374

F-value p-Value

Panel B: Test of equality of the coefficients (F-statistics)

LIQUID2= LIQUIDLIQUID2 25.16*** 0.000

CRDT_PAY= 1 398.30*** 0.000

CRDT_PAY+ CRDT_REV= 0 623.33

***

0.000This table reports the results of the regression of the association between the trade

creditvariables andcash holdings. PanelA presents the regression results and Panel

B shows the results of the test of equality of the coefficients. The constant term,

industry dummies, year dummies, and province dummies are included in the

regression but are not reported. The p-values, adjusted for clustering at the firm

level, are presented in parentheses below the estimates, where the definitions of

the variables are as presented inTable 1.* Significance at the 10% level.


12 As our sample is limited to publicly traded firms, which tend to find it easier to

secure loans when needed, the new receivables pledge policy may be not be

important to them. Our results will be understated in relation to non-publicly traded

firms. Therefore, the significant effect of the new policy on publicly traded firms

13 The global financial crisis that struck after 2007 may also have presented firms

with severe liquidity problems, in that it may have reduced the substitute ratio of

receivables for cash and required firms to hold more cash for payables. Thus, the

financial crisis is likely to have exerted a negative effect on the sensitivity of cash to

receivables, whereas the new receivables pledge policy probably exerted a positive

influence on the same measure. Our results suggest that the effect of the pledge policydominates that of the financial crisis.



10/16

result, as firms in regions with higher levels of financial deepening

have access to better financial services, meaning they are better

able to use receivables to factor or secure loans and thus benefit

more from the new receivables pledge policy. The new receivables

pledge policy can be treated as a de jure measure of financial

deepening, while the ratio of bank loans to GDP is a de facto

measure of financial deepening. The two measures complement

each other.

We include the three-way interaction term among CRDT_PAY,

DEEPEN, and the POLICY dummy and the three-way interaction

term among CRDT_REV, DEEPEN, and POLICY in Models (3)(5) to

test the difference in the impact of the new receivables pledge

policy between firms located in regions with lower and higher lev-els of financial deepening. We focus on the results of Model (5)

with the two three-way interaction terms. The coefficient of the

three-way interaction term amongCRDT_PAY,DEEPEN, andPOLICY

is insignificant, whereas that of the three-way interaction term

among CRDT_REV, DEEPEN, and POLICY is significantly negative.

These results also support our conjecture that the impact of the

new receivables pledge policy on receivables is more pronounced

for firms in regions with higher levels of financial deepening, but

the effect of the new policy on the payables of firms is no different

in regions with lower and higher levels of financial deepening.

As DEEPENis at the province-year level and POLICYis attheyear

level, the above regressions may not ruleout an alternativehypoth-

esis that factors other than financial deepening/pledge policy

change drive the results at the province-year level. To address thisconcern, we employ two firm-specific variables, related-party

tradesand state ownership,whichaffect thesensitivity of cashhold-

ings to trade credit, but are not related to the province-year level.14

5.5. Influence of related-party trades

The type of institution that is the counterparty of a trade credit

relationship may affect the sensitivity of cash holdings to payables

and receivables. Related parties are common counterparty types,

and can include shareholders, companies in the same group as

shareholders, and subsidiaries. Trades between listed firms and

these types of related parties are called related-party trades. The

close relationship between a firm and a related party reduces the

cost of delayed payment for payables and increases the probabilityof receivables being converted into cash when needed.

We use two dummies to capture whether a firm has engaged in

related-party sales or purchases. The dummy DRPT_BUYequals one

if a firm has engaged in a related-party trade as a buyer and zero

otherwise. The dummy DRPT_SELL equals one if a firm has engaged

in a related-party trade as the seller and zero otherwise. We em-

ploy regression models with interaction terms betweenDRPT_BUY

andCRDT_PAYand between DRPT_SELLandCRDT_REVfor the two

subsamples based on the level of financial deepening.

To compare the difference in the interaction terms between

firms located in regions with lower and higher levels of financial

deepening, we run a regression with three-way interaction terms

Table 5

Financial deepening and the relationship between trade credit and cash holdings.

Model 1: Subsample with a lower level of financial

deepening

Model 2: Subsample with a higher level of financial

deepening

Model 3 Model 4 Model 5

LIQUID2 0.294*** 0.428*** 0.359*** 0.359*** 0.359***

(0.000) (0.000) (0.000) (0.000) (0.000)

SIZE 0.040*** 0.053*** 0.048*** 0.048*** 0.048***

(0.000) (0.000) (0.000) (0.000) (0.000)

LEV 0.418***

0.452***

0.439***

0.438***

0.438***

(0.000) (0.000) (0.000) (0.000) (0.000)

DEBTM 0.164*** 0.216*** 0.189*** 0.189*** 0.189***

(0.000) (0.000) (0.000) (0.000) (0.000)

M/B 0.006 0.001 0.001 0.001 0.001

(0.114) (0.860) (0.694) (0.693) (0.688)

CAPEX 0.416*** 0.564*** 0.465*** 0.464*** 0.464***

(0.000) (0.000) (0.000) (0.000) (0.000)

CASHFLOW 0.463*** 0.561*** 0.510*** 0.511*** 0.510***

(0.000) (0.000) (0.000) (0.000) (0.000)

DIVIDEND 0.056*** 0.051*** 0.052*** 0.052*** 0.052***

(0.000) (0.000) (0.000) (0.000) (0.000)

TOP1 0.018 0.028* 0.010 0.009 0.010

(0.186) (0.075) (0.351) (0.382) (0.366)

STATE 0.012** 0.008 0.007** 0.007* 0.007*

(0.012) (0.169) (0.047) (0.051) (0.050)

DEEPEN 0.030 0.002 0.028* 0.029* 0.035**

(0.277) (0.932) (0.065) (0.058) (0.030)CRDT_PAY 0.720*** 0.709*** 0.792*** 0.715*** 0.775***

(0.000) (0.000) (0.000) (0.000) (0.000)

CRDT_REV 0.138*** 0.199*** 0.142*** 0.076** 0.090**

(0.000) (0.000) (0.000) (0.034) (0.014)

CRDT_PAY DEEPEN 0.077** 0.060**

(0.035) (0.048)

CRDT_REV DEEPEN 0.065** 0.050**

(0.028) (0.037)

Sample size 6668 6561 13,229 13,229 13,229

Adj-R2 0.352 0.389 0.375 0.375 0.375

This table reports the results of the regression of financial deepening on the relationship between trade credit and cash holdings. The constant term, industry dummies, year

dummies, and province dummies are included in the regression but are not reported. The p-values, adjusted for clustering at the firm level, are presented in parentheses

below the estimates, where the definitions of the variables are as presented in Table 1.* Significance at the 10% level.


14 We thank an anonymous referee for helping us to point out and address thisconcern.



11/16

among CRDT_PAY, DRPT_BUY, and DEEPEN, and among CRDT_REV,

DRPT_SELL, and DEEPEN. To capture the interactive effect of re-

lated-party trades and the new receivables pledge policy, we also

conduct a similar regression with three-way interaction terms

among CRDT_PAY, DRPT_BUY, and the POLICY year dummy, and

among CRDT_REV, DRPT_SELL, and POLICY. Table 8 reports the

regression results.

The results of Model (1) reported inTable 8show that the coef-

ficients of the interaction terms between DRPT_BUYandCRDT_PAY

and betweenDRPT_SELLandCRDT_REVare both significantly neg-

ative. This indicates that in regions with lower levels of financial

deepening, firms making related-party purchases tend to hold lesscash for payables, whereas the substitute ratio of receivables for

cash in firms making related-party sales tends to be higher. How-

ever, the results for Model (2) show that related-party trades do

not affect the sensitivity of cash holdings to trade credit in regions

with higher levels of financial deepening. Thus, the effect of re-

lated-party trades is mainly driven by firms in regions with lower

levels of financial deepening.

The results of Model (3) show that the three-way interaction

terms among DRPT_BUY, CRDT_PAY, and DEEPEN, and among

DRPT_SELL, CRDT_REV, and DEEPENare both significantly positive.

This indicates that related-party trades partially mitigate the prob-

lems imposed by lower levels of financial deepening. As a close

relationship with a related party can enable a firm to collect receiv-

ables more easily and reduce the cost of delayed payment for pay-ables when facing a cash shortage, firms that conduct related-party

trades do not need to keep as much cash for payables and can sub-

stitute more receivables for cash. In other words, the roles of re-

lated-party trades and financial deepening are substitutable.

Model (4) inTable 8shows the results for the interactive influ-

ence of related-party trades and the new receivables pledge policy

on the sensitivity of cash holdings to trade credit. The coefficient of

the three-way interaction term among CRDT_PAY, DRPT_BUY, and

POLICYis not significant, which indicates that the new receivables

pledge policy does not have a significantly different effect on the

sensitivity of cash holdings to payables between firms that have

engaged in related-party purchases and those that have not. How-

ever, the three-way interaction term amongCRDT_REV,DRPT_SELL,andPOLICY is significantly negative. This indicates that the new

receivables pledge policy has a stronger effect on the sensitivity

of cash holdings to receivables for firms that have engaged in re-

lated-party sales. Just as the new receivables pledge policy is com-

plementary to financial deepening in regard to the sensitivity of

cash holdings to receivables, it is also complementary to related-

party trades. These results also support our second hypothesis that

the new receivables pledge policy helps firms to increase the

substitute ratio of receivables for cash, but does not affect the sen-

sitivity of cash holdings to trade payables.

5.6. Influence of state ownership

During its gradual economic transition, China has maintainedextensive state control over the economy. Many government

Table 6

Impact of the new receivables pledge policy on the relationship between trade credit and cash holdings.

Model 1: Pre-2007 subsample Model 2: Post-2007 subsample Model 3 Model 4 Model 5

LIQUID2 0.369*** 0.357*** 0.361*** 0.360*** 0.360***

(0.000) (0.000) (0.000) (0.000) (0.000)

SIZE 0.049*** 0.046*** 0.048*** 0.049*** 0.049***

(0.000) (0.000) (0.000) (0.000) (0.000)

LEV 0.435*** 0.476*** 0.439*** 0.440*** 0.440***

(0.000) (0.000) (0.000) (0.000) (0.000)DEBTM 0.170*** 0.211*** 0.188*** 0.188*** 0.188***

(0.000) (0.000) (0.000) (0.000) (0.000)

M/B 0.010** 0.003 0.001 0.001 0.002

(0.013) (0.529) (0.656) (0.646) (0.631)

CAPEX 0.461*** 0.477*** 0.464*** 0.463*** 0.463***

(0.000) (0.000) (0.000) (0.000) (0.000)

CASHFLOW 0.477*** 0.538*** 0.510*** 0.513*** 0.512***

(0.000) (0.000) (0.000) (0.000) (0.000)

DIVIDEND 0.060*** 0.058*** 0.053*** 0.053*** 0.053***

(0.000) (0.000) (0.000) (0.000) (0.000)

TOP1 0.028** 0.020 0.009 0.009 0.009

(0.017) (0.345) (0.387) (0.380) (0.388)

STATE 0.009** 0.006 0.007** 0.008** 0.008**

(0.044) (0.371) (0.047) (0.043) (0.044)

DEEPEN 0.063*** 0.064*** 0.020 0.019 0.020

(0.000) (0.000) (0.174) (0.192) (0.178)

CRDT_PAY 0.747

***

0.738

***

0.742

***

0.722

***

0.735

***

(0.000) (0.000) (0.000) (0.000) (0.000)

CRDT_REV 0.155*** 0.203*** 0.142*** 0.124*** 0.126***

(0.000) (0.000) (0.000) (0.000) (0.000)

CRDT_PAY POLICY 0.064** 0.034

(0.020) (0.264)

CRDT_REV POLICY 0.084*** 0.069**

(0.002) (0.025)

Sample size 8892 4337 13,229 13,229 13,229

Adj-R2 0.348 0.390 0.375 0.375 0.375

In 2007, China adopted the Property Rights Law, which prescribes that accounts receivable can be used as collateral to borrow from banks. In accordance with the Property

Rights Law, Chinas central bank promulgated theMeasures forthe Registrationof Pledge Receivables in the same year. This table reports the results of regressions testing for

the influence of the new receivables pledge policy on the relationship between trade credit and cash holdings. The constant term, industry dummies, year dummies, and

province dummies are included in the regression but are not reported. The p-values, adjusted for clustering at the firm level, are presented in parentheses below the

estimates, where the definitions of the variables are as presented in Table 1. Significance at the 10% level.




12/16

regulations are discriminatory in nature, with large elite SOEs

receiving favorable treatment and protection from the state. An

important privilege enjoyed by SOEs is their ease of access to exter-

nal finance. This allows them not only to obtain loans from the

state banking system, but also to raise external finance through

seasoned equity offerings and rights issues. As a result of having

less financial constraints, SOEs hold less cash for forthcoming

payables and make better use of receivables as a cash substitute.

Therefore, like related-party trades, easier access to finance

makes state ownership a substitute for financial deepening. Thus,we predict that the effect of state ownership on the sensitivity of

cash holdings to trade credit will be less marked for firms in

regions with lower levels of financial deepening than for those

in regions with higher levels of financial deepening. We run similar

regression models to those reported in Table 8 by replacing

related-party trades with state ownership. The results are reported

inTable 9.

As shown in Model (1) ofTable 9, the coefficients of the interac-

tion terms between CRDT_PAYand STATEand between CRDT_REV

andSTATEin the subsample with lower levels of financial deepen-

ing are both significantly negative. This suggests that fewer financ-

ing constraints help SOEs to reduce the cash held to cover payables

and to increase the substitute ratio of receivables for cash. How-

ever, in Model (2) for the subsample with higher levels of financialdeepening, the coefficient of the interaction term between

CRDT_PAYandSTATE is positive but not significant, whereas that

of the interaction term between CRDT_PAYand STATEis marginally

significantly negative. This indicates that in regions with high

levels of financial deepening, state ownership does not exert a sig-

nificant impact on the sensitivity of cash holdings to trade credit.

These results suggest that the effect of state ownership on the sen-

sitivity of cash holdings to receivables is greater among firms in re-

gions with lower levels of financial deepening than among those in

regions with higher levels of financial deepening. State ownership

serves as a substitute for financial deepening in the relation be-tween trade credit and cash holdings.

Model (3) ofTable 9reports the results of models with three-

way interaction terms among CRDT_PAY, STATE, and DEEPEN, and

among CRDT_REV, STATE, and DEEPEN. The coefficients of these

three-way interaction terms are both significantly positive. This

suggests that the differences in the impact of state ownership on

the sensitivity of cash holdings to trade credit between firms in

regions with different levels of financial deepening are statistically

significant. The effects are more pronounced in regions with lower

levels of financial deepening than in those with higher levels of

financial deepening. These results also support the findings of

Models (1) and (2) that the roles of state ownership and financial

deepening are substitutable.

Model (4) ofTable 9 presents the results of the interactive effectof state ownership and the new receivables pledge policy on the

Table 7

Interaction of the impact of the new receivables pledge policy and financial deepening on the relationship between trade credit and cash holdings.

Model 1: Pre-2007 subsample Model 2: Post-2007 subsample Model 3 Model 4 Model 5

LIQUID2 0.374*** 0.358*** 0.360*** 0.359*** 0.360***

(0.000) (0.000) (0.000) (0.000) (0.000)

SIZE 0.049*** 0.046*** 0.048*** 0.049*** 0.049***

(0.000) (0.000) (0.000) (0.000) (0.000)

LEV 0.439*** 0.476*** 0.439*** 0.440*** 0.440***

(0.000) (0.000) (0.000) (0.000) (0.000)DEBTM 0.176*** 0.201*** 0.189*** 0.189*** 0.189***

(0.000) (0.000) (0.000) (0.000) (0.000)

M/B 0.010*** 0.001 0.001 0.001 0.001

(0.008) (0.778) (0.675) (0.659) (0.659)

CAPEX 0.458*** 0.470*** 0.463*** 0.462*** 0.462***

(0.000) (0.000) (0.000) (0.000) (0.000)

CASHFLOW 0.472*** 0.542*** 0.510*** 0.513*** 0.512***

(0.000) (0.000) (0.000) (0.000) (0.000)

DIVIDEND 0.056*** 0.055*** 0.052*** 0.053*** 0.053***

(0.000) (0.000) (0.000) (0.000) (0.000)

TOP1 0.015 0.017 0.009 0.009 0.009

(0.203) (0.411) (0.375) (0.375) (0.378)

STATE 0.010** 0.000 0.007* 0.007** 0.007**

(0.032) (0.954) (0.052) (0.047) (0.048)

DEEPEN 0.073*** 0.043 0.038** 0.037** 0.038**

(0.000) (0.737) (0.019) (0.020) (0.018)

CRDT_PAY 0.807

***

0.806

***

0.779

***

0.769

***

0.771

***

(0.000) (0.000) (0.000) (0.000) (0.000)

CRDT_REV 0.145*** 0.079 0.085** 0.078** 0.077**

(0.001) (0.319) (0.022) (0.036) (0.037)

CRDT_PAY DEEPEN 0.055 0.080 0.043 0.046 0.042

(0.243) (0.264) (0.269) (0.226) (0.276)

CRDT_REV DEEPEN 0.007 0.125* 0.054* 0.047 0.049

(0.844) (0.093) (0.098) (0.152) (0.138)

CRDT_PAY DEEPEN POLICY 0.050** 0.017

(0.041) (0.555)

CRDT_REV DEEPEN POLICY 0.070*** 0.061**

(0.004) (0.035)

Sample size 8892 4337 13,229 13,229 13,229

Adj-R2 0.359 0.396 0.375 0.375 0.375

This table reports the results of regressions testing for theinfluence of thenew receivables pledge policy onthe relationship betweentradecredit andcash holdings in regions

with different levels of financial deepening. The constant term, industry dummies, year dummies, and province dummies are included in the regression but are not reported.

Thep-values, adjusted for clustering at the firm level, are presented in parentheses below the estimates, where the definitions of the variables are as presented in Table 1.* Significance at the 10% level.




13/16

relation between trade credit and cash holdings. The coefficient of

the three-way interaction term amongCRDT_PAY,STATE, andPOL-

ICY is not significant, while that of the interaction term among

CRDT_REV, STATE, and POLICY is significantly negative. This sug-

gests that the effect of the new receivables pledge policy on the

sensitivity of cash holdings to trade receivables is greater for SOEsthan for non-SOEs, whereas the effect of the new receivables

pledge policy on the sensitivity of cash holdings to trade payables

is no different between SOEs and non-SOEs. Similar to the results

for related-party trades, these results also support our second

hypothesis that the new receivables pledge policy helps firms to

increase the substitute ratio of receivables for cash, but does not

affect the sensitivity of cash holdings to trade payables.

5.7. Two-stage analysis

We conduct five two-stage instrumental variable regressions

similar to the models presented in Table 5. For each model, we re-

port only the coefficient of the lagged cash holdings estimated in

the first stage to account for the presence of reverse causality,and the coefficients of trade payables and receivables (CRDT_PAY

and CRDT_REV) or their interaction term with the financial deepen-

ing measure, which reflect the coefficients corrected for endogene-

ity. The results are reported inTable 10.

The coefficients of lagged cash are significant in all five models

in which the dependent variable is trade payables (CRDT_PAY). This

suggests that cash has a positive impact on trade payables, in thatfirms that hold more cash are more likely to use trade payables to a

greater extent in their operations. All of the models other than

Model (1) have significantly negative coefficients on the lagged

cash ratio for the regressions of trade receivables. This provides

some evidence that firms that hold more cash tend to hold less

trade receivables. In common with the results reported in Table

10, the coefficients of CRDT_PAYand CRDT_REVand their second-

stage interaction terms are all significant. Overall, these results

show that our conclusions hold after correcting for the endogene-

ity problem.

6. Conclusion

In this study, we investigate the relationship between tradecredit and cash holdings and how it is affected by financial

Table 8

Related-party trades and the relationship between trade credit and cash holdings.

Model 1: Subsample with a lower level of financial

deepening

Model 2: Subsample with a higher level of financial

deepening

Model 3 Model 4

LIQUID2 0.292*** 0.430*** 0.359*** 0.359***

(0.000) (0.000) (0.000) (0.000)

SIZE 0.038*** 0.052*** 0.043*** 0.043***

(0.000) (0.000) (0.000) (0.000)

LEV 0.419***

0.459***

0.448***

0.447***

(0.000) (0.000) (0.000) (0.000)

DEBTM 0.161*** 0.216*** 0.192*** 0.192***

(0.000) (0.000) (0.000) (0.000)

M/B 0.007* 0.007* 0.010*** 0.010***

(0.055) (0.089) (0.000) (0.000)

CAPEX 0.416*** 0.569*** 0.493*** 0.494***

(0.000) (0.000) (0.000) (0.000)

CASHFLOW 0.459*** 0.535*** 0.483*** 0.483***

(0.000) (0.000) (0.000) (0.000)

DIVIDEND 0.055*** 0.055*** 0.056*** 0.056***

(0.000) (0.000) (0.000) (0.000)

TOP1 0.006 0.037** 0.011 0.010

(0.671) (0.020) (0.299) (0.331)

STATE 0.008* 0.006 0.008** 0.008**

(0.084) (0.260) (0.029) (0.028)

DEEPEN 0.040 0.030* 0.037*** 0.036***

(0.148) (0.098) (0.002) (0.002)CRDT_PAY 0.766*** 0.785*** 0.799*** 0.800***

(0.000) (0.000) (0.000) (0.000)

CRDT_REV 0.098*** 0.199*** 0.149*** 0.149***

(0.000) (0.000) (0.000) (0.000)

CRDT_PAY DRPT_BUY 0.088*** 0.030 0.127*** 0.096***

(0.001) (0.365) (0.005) (0.000)

CRDT_REV DRPT_SELL 0.089*** 0.018 0.103*** 0.055***

(0.000) (0.445) (0.001) (0.001)

CRDT_PAY DRPT_BUY DEEPEN 0.024**

(0.038)

CRDT_REV DRPT_SELL DEEPEN 0.054***

(0.003)

CRDT_PAY DRPT_BUY POLICY 0.023

(0.332)

CRDT_REV DRPT_SELL POLICY 0.051**

(0.025)

Sample size 6668 6561 13,229 13,229Adj-R2 0.356 0.387 0.367 0.367

This table reports the results of the regression of related-party trades on the relationship between trade credit and cash holdings. The constant term, industry dummies, year,

and province dummies are included in the regression but are not reported.

Trade Credit, Cash Holdings, And Financial Deepening

Documents

Transcript of Trade Credit, Cash Holdings, And Financial Deepening