Demand Shock, Liquidity Management, and Firm Growth during the Financial Crisis

We examine the transmission of liquidity across the supply chain during the 2007-09 financial crisis, a period of financial market illiquidity, for a sample of unrated public firms with differential demand shocks. We measure differential demand by comparing firms that primarily supply to government customers with those that primarily supply to corporate customers. A difference-in-difference analysis shows little evidence that relatively high demand firms provide more or less liquidity to their own suppliers. The main determinant of the usage of short-term financing is a product market shock. Firms with relatively high demand have higher raw-material inventory and use more trade credit. There is little evidence that the amount of credit usage per unit of raw-material inventory changes with firms' demand shocks. These outcomes are consistent with theories of trade credit that stress the use of trade credit in financing inputs rather than providing efficient monitoring of creditors by suppliers. The lack of liquidity provision to suppliers by high demand firms is likely due to the high opportunity costs they face: We show that such firms become more investment-constrained over the crisis and engage in more acquisition activities once the liquidity crunch dissipates.