Poultry in Motion: A Study of International Trade Finance Practices
Executive Summary — When engaging in international trade, exporters must decide which financing terms to use in their transactions. Should they ask the importers to pay for goods before they are loaded for shipment, ask them to pay after the goods have arrived at their destination, or should they use some form of bank intermediation like a letter of credit? In this paper, Pol Antrąs and C. Fritz Foley investigate this question by analyzing detailed data on the activities of a single US-based firm that exports frozen and refrigerated food products, primarily poultry. The data cover roughly $7 billion in sales to more than 140 countries over the 1996-2009 period and contain comprehensive information on the financing terms used in each transaction. Key concepts include:
- Firms that are likely to have the highest costs of obtaining external capital tend to be the ones that need it most. Importers are more likely to transact on cash in advance terms when they are based in countries with weak institutions, and external capital also tends to be particularly expensive in these countries.
- Firms in weak institutional environments are able to overcome the constraints of such environments if they can establish a relationship with their trading partners. As a relationship develops between trading partners, concerns about weak institutions seem to subside, and transactions are more likely to occur on terms that allow payment after goods have arrived.
- The manner in which trade is financed shapes the impact of macroeconomic and financial crises such as the recent one. For instance, the data show that importers who were transacting on cash in advance terms before the recent crisis reduced their purchases the most.
This paper analyzes the financing terms that support international trade and sheds light on how and why these arrangements affect trade. Using detailed transaction level data from a US based exporter of frozen and refrigerated food products, primarily poultry, it begins by describing broad patterns about the use of alternative financing terms. These patterns help discipline a model in which the trade finance mode is shaped by the risk that an importer defaults on an exporter and by the possibility that an exporter does not deliver goods as specified in the contract. The empirical results indicate that transactions are more likely to occur on cash in advance or letter of credit terms when the importer is located in a country with weak contractual enforcement and in a country that is further from the exporter. Letters of credit, however, are rarely used by the exporter. As an importer develops a relationship with the exporter, transactions are less likely to occur on terms that require prepayment. During the recent crisis, the exporter was more likely to demand cash in advance terms when transacting with new customers and customers that traded on cash in advance terms prior to the crisis disproportionately reduced their purchases. These results can be rationalized by the model whenever (i) misbehavior on the part of the exporter is of little concern to importers, and (ii) local banks in importing countries are typically more effective than the exporter in pursuing financial claims against importers.