09-05-2025
Study finds bankruptcy fears impact trade credit decisions of small businesses
A study by researchers has found that people behave differently from established theoretical models when they are faced with bankruptcy, particularly in small business settings.
The researchers studied the supply chain business and trade credit models to understand the possibility of better supplier-retailer contracts. Vipin B, assistant professor from the Department of Management Studies at Indian Institute of Technology Madras and a research scholar from IIT Kanpur conducted an experimental study to understand the behaviour of financially constrained retailers, including startups and small businesses, and their inventory decision making patterns in uncertain market demand conditions.
Mr. Vipin and Mohd. Mujahid Khan, a research scholar from IIT Kanpur jointly conducted the research, and their findings were published in the Journal of Operations Management.
When faced with the possibility of bankruptcy retailers consistently ordered less than predicted by theoretical models.
'We have done an experiment and compared with the theoretical prediction existing in literature. We found that actual behaviour is different from what the theory predicts,' he said.
Theoretical models have failed to capture the actual behaviour of humans, he added. 'We developed a model to describe the behaviour observed in our experiment. We considered a financially constrained supplier. A retailer could get credit from the supplier, which is common across the globe. But there is a possibility that if the retailer does not get enough revenue, they cannot pay the supplier, with a possibility of bankruptcy,' he said.
The researchers created two scenarios for retailers to decide on the order quantity – becoming bankrupt or surviving it. 'Our research aligns with Daniel Kahneman's Prospect Theory,' Mr. Vipin said. The experiment, a rational model, accurately captured the phenomenon, he remarked.
If retailers feared a bankruptcy risk, they ordered lower, unlike what the theory predicted. The pattern depends on the profit margin of the product. Suppliers order more products with a low profit margin and less for high profit margin products. Bankruptcy risk leads to consistent underordering. Though interest rates are competitive the inclusion or exclusion of interest in trade credit does not significantly influence the retailers' ordering behaviour, their experiment found.
The researchers call for identifying the gap between theoretical and actual scenarios. Behaviourally biased people who under-order consistently must be incentivised. They suggest trade credit designs to combat uncertain markets. Financial institutions and fintechs could come up with targeted interventions for micro, small and medium enterprises in developing economies where access to finance is limited.
In a 2019 report, the World Trade Organisation stated that 80% of global trade finance depended on short-term trade credit or credit guarantees, highlighting the relevance of trade credit in business. Trade financing was estimated to be USD 1.5 trillion annually, with around 40% concentrated in developing Asian countries.
