High-bargaining-power (low-bargaining-power) customer (supplier) firms borrow (lend) more trade credit according to the literature. We study whether this bargaining power effect strengthens or weakens when the credit supply tightens. We construct a Nash bargaining model of trade credit and show that the bargaining power effect weakens if their financing costs increase more than that of the customers. We find support for our theory using a unique database of listed firms in China that discloses firms’ transaction information with important customers and suppliers. Interest-rate sensitive suppliers, proxied by a non-state ownership, a high debt rollover risk, and a high financial constraint index, reduce trade credit to their high-bargaining-power customers during credit contractions.

Studying China’s credit market, we find improved price efficiency and, paradoxically, worsening segmentation as perceived government support for state-owned enterprises (SOEs) caused non-SOE credit spreads to explode rather dramatically relative to their SOE counterparts amid government-led credit tightening. Interestingly, the post-2018 credit-market stress helped improve price efficiency within non-SOEs, while SOEs saw no such improvement and instead became sensitive to issuer-level measures of government support, marking a shift of SOE premium beyond the SOE label. We further document the real impact of the deepening credit misallocations: non-SOEs in aggregate are losing their long-standing advantage in profitability over SOEs in China.