Convertible Trade Credits: a new way of creating value

Abstract

This paper aims to explore the possibility of a vendor supporting a firm’s growth opportunities in sequential financing rounds in exchange for shares in the firm’s common stock. We departed from an initial setup where a firm has a positive NPV growth opportunity and easy access to financing (Myers and Read, 2020). We moved forward to set up a scenario where the firm had difficulties raising funding for the same real call option and asked whether it would be advantageous to rely on key vendors to finance it. The answer to the question was affirmative.

We found that the new proposed Convertible Trade Credits Contract creates value for both parties in the transaction by allowing the firm to realize the growth opportunity <optimal investment policy> while sharing risks and returns with the vendor <diversification>. We relied on discrete binomial event trees to price real call options and the constant dividend growth model to price the firm’s stock under different states of nature. The example we provide assumes a world with no corporate taxes.