TRADE CREDIT DEPENDENCE AND DYNAMIC CAPITAL STRUCTURE INEFFICIENCY: EVIDENCE FROM PAKISTAN

Abstract

This study examines the relationship between trade credit dependence and firm capital structure dynamics within the unique economic environment of Pakistan. Despite the presence of a bank-dominated financial system, Pakistani companies largely use supplier financing. Using a dynamic panel dataset of non-financial firms listed on the KSE-30 index from 2010 to 2023, this research investigates whether such reliance on trade credit leads to inefficiencies in the adjustment of leverage towards optimal levels. The results of the system's GMM calculations confirm a strong substitution effect between trade credit and formal bank credit. More importantly, the analysis shows that higher trade credit dependence significantly reduces the speed of adjustment of a firm's capital structure, indicating a loss of financial flexibility. This dynamic inefficiency is more pronounced for financially constrained firms and companies embedded in family- owned business groups. The findings show that while trade credit provides necessary short-term liquidity, it also imposes long-term costs by preventing timely financial rebalancing. This research contributes to the understanding of capital structure behavior in emerging markets and provides insights for corporate financial management and financial sector policy in Pakistan.