A counterexample to the findings in the finance and development literature is that firms have achieved good performance in many developing economies where the financial sector is far from established. One widely suggested mechanism in the literature is that firms in these developing economies use a high ratio of informal financing, i.e., trade credit. This paper, by using a survey of firms in China conducted by the World Bank in early 2003, examined the impact of trade credit on firm performance. The ordinary least squares estimations showed that trade credit was significantly and positively correlated with firm performance. However, after we used the instrumental variable approach to tackle the potential endogeneity issues, trade credit no long
had any impact on firm performance. The results were robust with a
series of robustness checks. Our study suggested that the role of trade
credit in promoting firm performance was limited.