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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: wfwu@sjtu.edu.cn (W. Wu), oliver@baf.msmail.cuhk.edu.hk
(O.M. Rui), cfwu@sjtu.edu.cn(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:wfwu@sjtu.edu.cnmailto:oliver@baf.msmail.cuhk.edu.hkmailto:cfwu@sjtu.edu.cnhttp://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:cfwu@sjtu.edu.cnmailto:oliver@baf.msmail.cuhk.edu.hkmailto:wfwu@sjtu.edu.cnhttp://dx.doi.org/10.1016/j.jbankfin.2011.04.0097/25/2019 Trade Credit, Cash Holdings, And Financial Deepening
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).
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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
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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).
W. Wu et al. / Journal of Banking & Finance 36 (2012) 28682883 2871
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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.
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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.
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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.
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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.
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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.
** Significance at the 5% level.*** Significance at the 1% 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.
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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.
** Significance at the 5% level.*** Significance at the 1% level.
14 We thank an anonymous referee for helping us to point out and address thisconcern.
W. Wu et al. / Journal of Banking & Finance 36 (2012) 28682883 2877
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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.
** Significance at the 5% level.*** Significance at the 1% level.
2878 W. Wu et al. / Journal of Banking & Finance 36 (2012) 28682883
7/25/2019 Trade Credit, Cash Holdings, And Financial Deepening
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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.
** Significance at the 5% level.*** Significance at the 1% level.
W. Wu et al. / Journal of Banking & Finance 36 (2012) 28682883 2879
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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.
Recommended