Sunday, July 25, 2021
Motivated by payment terms observed in regulatory reporting data, we construct a signalling model to analyse how late payments affect market entry and price competition in business-to-business transactions. Buyers first signal a payment term to potential suppliers, either standard or extended. Suppliers then decide whether to incur a fixed and irreversible cost to enter into competition for the contract. After the seller and the winning bid is determined, the buyer chooses whether or not to honour the agreed payment term. We show theoretically that late payments feed into higher prices and reduced competition. Reneging on a standard payment term entails a penalty for the buyer. If this penalty is not set carefully, a welfare loss arises due to price spillover effects in the market. The effectiveness of the penalty is diluted when it accrues as interest to the creditor, relative to when it is collected by a third party. We provide experimental evidence that the probability of a timely payment responds to the institutional environment, that free-riding behaviour may emerge among weaker firms, and that extended payment terms reduce consumer surplus. Our findings have implications for the horizontal effects of supply chain payment practices and for the design of regulatory interventions to deter late payments.