Case studies of enterprise finance in Ghana

Case Study Series . " 56875 •• Case Studies of Enterprise Finance in Ghana Droft Carlos Cuevas, Marcel Fafchamps, Rebecca Hanson, Peter Moll and Pradeep Srivastava The views and interpretations expressed in this study are solely those of the authors. They. do not necessarily represent the views of the World Bank or its member countries and . should not be attributed to the World Bank or its affiliated organizations.  REGIONAL PROGRAM ON ENTERPRISE DEVELOPMENT Case Studies of Enterprise Finance in Ghana Final Report EXECUTIVE SUMMARY This study addresses and cha1lenges a number of common propositions underlying financia1 market interventions, in search of a1ternative avenues for policy reform and donor intervention in Ghana. The study is concerned with the capitaJ structure of enterprises, not just their externa1 borrowing or their "credit needs", because it attempts to establish the true incidence of externa1 finance in firm behavior and, in doing so, identify a1ternative means of fostering enterprise development. The study looks into the financial components of inter-firm transactions, because it pursues unveiling the role of trade credit in enterprise finance, and eva1uating the potential for these linkages to be exploited in innovative policy interventions. In addition, the study elucidates the nature and relevance of informal finance in the firm's environment, assessing the conditions and limitations of informa1 contracts. Finally, the study looks into the lega1 constraints that bind the operations of forma1 financia1 institutions and restrict the ability of firms and individua1s to engage in financia1 transactions. This report presents findings, ana1yses, and policy implications and recommendations emerging from comprehensive literature reviews, and extensive field work carried out in Ghana in January 1993. The main conclusions and policy implications derived from our findings and analyses are outlined below. The Formal Financial Sector and the Incentives Structure The analysis of debt portfolios presented here revealed the significance of internal sources in enterprise finance, and the striking role of trade credit in supporting current firm operations. These findings suggest that the long-standing lending programs targeted to sma11 enterprises through forma1 banking institutions have been unsuccessful, and that targeting credit to sma11 firms is futile when large firms may be effective conduits to increase liquidity among medium and sma1l-scale firms through trade- credit linkages. The banks' genera1 reluctance to lend is explained primarily by the incentive structure banks face, where attractive and secure government bonds and money market "investments" favorably compete with firms of unclear credit worthiness. These factors preclude the dir~ct access to bank funding for these enterprises, and in addition constrain the availability of bank funds for well-established, fully secured, large firms which could otherwise perform the role of intermediaries in connection with their regular commercia1 activities. Thus a drastic change in the incentive structure surrounding formal financia1 institutions is ca1led for, if lending to manufacture is to increase. The competition represented by treasury bills and the low- but-safe return offered by money-market transactions appears to be too strong for manufacture loan contracts which are costly to carry out and enforce. The discussion of the legal and regulatory framework for financia1 institutions and firms highlighted the constraints on access to formal credit imposed by the current system of land ownership and transfer regulations, and the disincentives these regulations entail for banks to engage in private sector lending. Furthermore, the preference of banks for fixed property as loan security, along with their reluctance to take accounts receivable as collateral revealed a basic inconsistency between what manufacturing enterprises are in a position to offer vis a vis what banks regard as acceptable collateral. Strengthening Informal Finance Informal credit appears to play an important role in the financing of small and medium enterprises in Ghana's manufacturing sector. These enterprises place significant reliance on informal finance for both start~up capital as well as incremental investments, although own savings for the former and retained earnings for the latter playa far more dominant role as source of funds. There is also evidence that firms use informal loans on a short-term basis for liquidity management. The most significant findings relevant to policy decisions relate to the observed underdevelopment of informal financial markets. Absence of such markets is remarkable given the high incidence of informal finance in Ghana and the pervasiveness of such informal financial markets in developing countries. Consequently, a major policy objective should be to facilitate the development of informal financial markets in Ghana. Although the government or donor agencies do not have any direct mechanisms towards this objective, the findings in this study suggest some possible interventions and caution against some others. Specifically, with respect to the latter, if the absence of informal credit markets suggests structural impediments, i.e., costs of transaction high enough to prevent the markets from being organized, interventions aimed at increasing availability of loanable funds in the market may not be productive. Positive interventions, on the other hand, would aim to reduce the transaction costs of lending, enabling private individuals to organize market-based arrangements. Another policy measure that can be used by the government and donor agencies to foster development of informal credit markets is through encouraging existing business associations to "make" informal markets, in the sense of regulating and enforcing consensual norms for credit transactions. Enterprise Financing through Trade Credit This study has demonstrated that in the manufacturing sector in Ghana trade credit was by far the most important source of credit for small firms, and a highly significant source for firms of all sizes. A major policy intervention suggested by the findings concerns the concept of the trade credit multiplier, or the linkage between formal banking sector finance to large firms and trade credit to small firms. A good deal of evidence was presented that bank loans were on-lent to cJ ient firms in the form of trade credit, provided certain conditions were fulfilled. Among these conditions were the following. First, the supplier firm had to be faced with competition so that it had an incentive to provide trade credit in order to move its goods. Second, the product had to bulk sufficiently large in the requirements of clients that it was worth while forming a long-term relationship. Third, the supplier firm and the client firm had to have a relationship of considerable standing. In many cases, small firms obtained trade credit from their suppliers only after buying from them on a cash basis for several years. Provided these three conditions were fulfilled, loans from the banking sector were likely to be translated into trade credit for clients, hence the concept of the trade credit multiplier, which connotes ii a ripple effect throughout the economy and in particular in the sman-firm sector following an infusion of capital in the large-firm sector. There is, therefore, a justification to design financial market interventions that exploit this trade- credit connection. Although no specific criteria is formulated, the discussion here suggests that a relativel y mild targeting criteria would take into account the market structure of the industries in question, and the knowledge acquired during the program preparation about the prevalence of trade credit in the enterprise sector being considered for intervention. The policies and programs would then focus on those sectors where trade credit is extensive or where it offers significant growth potential. The temptation to design targeting requirements that involve "certifying" existing or alleged trade-credit connections with small firms should be strongly resisted. Instead, policies should create the adequate incentives for trade- credit connections to develop and strengthen, while finance is expanded "at the top". Increased access to finance by the private sector at large, the elimination of credit allocation policies that limit businesses in their access to funds, and the introduction of modem financial technology should be the essential ingredients of policy interventions aimed at exploiting the trade credit multiplier. Contracting and Credit Rating A number of implications from the analysis of the legal system and contracts point towards interventions and policy changes that would improve the contracting environment for enterprises in Ghana. Expediting formal adjudication procedures through introducing simple modem technology in the courts, and establishing a system of small claims courts would reduce the cost of legal proceedings and help bring the court system closer to Ghanaian businesses. Another area of possible intervention is credit checking, which would allow new and smaller firms to establish credit-worthiness more quickly than they now do. Currently it takes years of cash purchases for these firms to earn the privilege of buying on credit. A credit checking facility would provide to suppliers information on potential client's financial activities, which could result in establishing trade credit relationships more quickly, and with longer terms and higher ceiJings. Credit rating agencies could be established using information on bounced checks, existing overdrafts, loans, mortgages on commercial and industrial property, pending law suits and unfavorable judgements. A "Credit Reporting Act" may be necessary to provide protection for individuals and for firms against abuses of the credit rating system. iii  TABLE OF CONTENTS EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I. INTRODUCTION .............................................. . II. ENTERPRISE FINANCE IN GHANA: A CRITICAL ASSESSMENT . . . . . . . . . . . . . . 4 A. Enterprise Portfolio Cboice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 4 1. Investment in Capital Stock and Sources of Finance . . . . . . . . . . . . .. 5 2. Enterprise Debt Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7· B. Enterprise Finance and the Formal Banking Sector . . . . . . . . . . . . . . . . . . . 11 C. Informal Credit and Enterprise Finance . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1. Scope and Extent of Informal Credit . . . . . . . . . . . . . . . . . . . . . . 14 2. Sources and Uses of Informal Credit . . . . . . . . . . . . . . . . . . . . . . 17 3. Contracts, Institutions and Markets in Informal Finance . . . . . . . . . . 19 D. The Legal and Regulatory System and Enterprise Finance .. . . . . . . . . . . .. 23 1. The Role of Land Ownership and Transfer Regulations . . . . . . . . . .. 23 2. Analysis of Banks' Portfolios by Type of Security . . . . . . . . . . . . .. 28 3. Constraints on Debt Collection and Enforcement . . . . . . . . . . . . . .. 29 m. TRADE CREDIT AND ENTERPRISE FINANCE . . . . . . . . . . . . . . . . . . . . . . . . . 35 A. Theoretical Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 B. Trade Credit and Enterprise Finance: The FactS . . . . . . . . . . . . . . . . . . . . 48 1. The Food Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 2. Textiles and Garments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 3. Wood Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 4. The Metal Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 C. Trade Credit Terms, Conditions and Motives . . . . . . . . . . . . . . . . . . . . . . 58 D. The Nature and Enforcement of Trade Credit Contracts . . . . . . . . . . . . . . . 75 1. Causes for Breaches of Contract . . . . . . . . . . . . . . . . . . . . . . . . . 76 2. Flexibility versus "Hard Contract" Constraints . . . . . . . . . . . . . . . . 78 3. Risk Assessment as Constrained by Lack of Information . . . . . . . . .. 79 4. Current Modes of Contract Enforcement in Ghana. . . . . . . . . . . . .. 79 IV. CONCLUSIONS AND POLICY IMPLICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . 84 A. The Formal Financial Sector and the Incentives Problem . . . . . . . . . . . . . . . 84 B. Strengthening Informal Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 C. Enterprise Financing through Trade Credit . . . . . . . . . . . . . . . . . . . . . . . 86 D. Contracting and Credit Rating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 REFERENCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 APPENDIX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 iv  REGIONAL PROGRAM ON ENTERPRISE DEVELOPMENT Case Studies of Enterprise Finance in Ghana Final Report 8 May 1993 I. INTRODUCTION The financial component of the RPED study focuses on the role finance plays in firm dynamics. Within the framework of RPED, it is not only the quantitative aspects of credit availability that are of interest but also qualitative aspects related to contractual attributes. While almost no data exists on the latter. evidence with respect to the quantitative availability of credit to enterprises is somewhat fragmentary, and primarily focused on the small- and medium-sized firms, a common concern of governments and donors. Finally, issues relating specifically to trade credit availability and attributes are conspicuous by their virtual absence. A natural starting point for the present analysis is to investigate how firms finance their operations, including start-up capital and working capital. However, the available studies provide little systematic evidence on this issue. A possible reason is that the unit of analysis in the reports is the formal financial institution rather than the enterprise: the objective in the studies has been to evaluate the efficacy of the financial sector and its capacity for meeting the financing "needs" of the private sector, especially the small- and medium-scale enterprises (SMEs). This "top-down" approach typically looks at the portfolios of banks, specifically at the proportion of loans made to small and medium enterprises; these proportions are inevitably quite small although they have been rising in recent years. Between 1980 and 1983, the manufacturing sector received an annual average of 17.2% of the loans and advances provided by the primary banks (Le., the major commercial banks) and 23.2% of the loans of the secondary banks (Le., all others excluding rural banks). Since 1984, the share of loans to manufacturing has increased from 20.5% to 29.5% in 1990 while the same figures for loans from secondary banks have risen from 35.9% to 38.6%, (World Bank(1991». These aggregates, however, include firms of all sizes. The notion that banks do not provide adequate financing to SMEs, leaving them credit constrained, is quite common. Indeed, virtually all industrial or small-enterprise surveys in Ghana have reported high proportions of firms citing lack of access to credit as a major constraint. The usual reasons that lead to bias against small-firm loans, in the form of higher costs per unit and greater informational problems, are also noted by most studies. In addition to the perceived inadequacy of SME financing by banking sector, other issues attracting interest in Ghana have been the impact of recent financial sector reforms on the ability of formal financial institutions to finance SMEs, the ways in which the access of SMEs to formal financial credit can be enhanced, and the extent to which the informal financial sector can play an important role in the mobilization and allocation of financial savings. There is also some discussion on policies for increasing linkages between informal intermediaries and the formal fmancial institutions . The recent financial sector reforms led to the removal of credit ceilings on banks, the elimination of direct controls on interest rates, and broad based balance sheet restructuring of the banks. In addition, there were also attempts at financial deepening through the creation of money markets. It is recognized that the impact of the financial sector reforms on greater intermediation efficiency and financial deepening  2 in general, and on improved financing of SMEs in particular, has been less than desired or expected. Of specific interest, in the context of SME financing, is the experience of the special SME Credit program that was set up as part of the financial sectOr restructuring with the specific aim of enhancing access of small and medium scale enterprises to formal sector credit. A number of causes have been identified for the limited success of the SME Credit program. One set of reasons pertains to the unwillingness of banks to use the facility due to higher cost of funds: the cost of SME funds is based on the cost to banks of mobilizing deposits in the preceding period, implying higher costs (than direct mobilization and lending) in a period when interest rates are declining, as has been true for most of 1992. But other reasons for the lackluster performance of the SME Credit program are more structural, relating to the constraints on banks' ability to make loans to small enterprises, and the high administrative costs associated with loans to this clientele. In addition to the higher unit costs of approval, monitoring and supervision of small loans, SME financing is also constrained frequently by lack of adequate collateral and equity. Furthermore, legal enforcement problems with tangible security are attributed to the quality of titles obtainable on land, lengthy court procedures and the reluctance of judges to evict people from their homes. Both the policy interventions in Ghana as well as their supporting studies seem inspired in a number of propositions comprising the "conventional wisdom" of policy actions in many countries and institutions. This study addresses and challenges this perceived wisdom, in search of alternative avenues for policy reform and donor intervention in Ghana. Thus the objectives of the study set forth below question, for the most part, the central propositions underlying the conventional approach. Objectivt>S Financial market interventions such as the SME credit project referred to above rely upon the notions that: (i) credit, i.e., debt, is essential for firm entry and growth; (ii) direct lending by financial institutions is the only feasible way of reaching enterprises, even those of small scale; (iii) financial markets are fragmented; and (iv) informal finance is ineffective in helping enterprise development, informal intermediaries being for the most part evil usurers. In addition, no attention has been given to the potential role of trade credit in the provision of finance to firms of different sizes, or to the limitations to enterprise fmance implicit in credit allocation policies that restrict the share of commerce in banks' portfolios. Likewise, the conventional approach to the design of interventions underestimates the importance of legal and regulatory barriers inside and outside the financial sector. This study is concerned with the capital structure of enterprises, not just their external borrowing, because it attempts to establish the true incidence of external finance in firm behavior and, in doing so, identify alternative means of fostering enterprise development. The study looks into the financial components of inter-firm transactions, because it pursues unveiling the role of trade credit in enterprise finance, and evaluating the potential for these linkages to be exploited in innovative policy interventions. In addition, the study elucidates the nature and relevance of informal finance in the firm's environment, assessing the conditions and limitations of informal contracts. Finally, the study looks into the legal constraints that bind the operations of formal financial institutions and restrict the ability of firms and individuals to engage in financial transactions.  3 The Report This report presents findings, analyses, and policy implications emerging from our interviews with some sixty manufacturing firms. a number of textile and lumber traders, and several financial and legal institutions operating in Ghana. The case studies included a total of 39 firms selected among those interviewed in the panel survey by the Oxford team. Our case-study interviews build upon the responses provided by the firms during the panel survey to substantially expand the information on financial transactions, especially trade-credit practices, and review conflict resolution and contract enforcement mechanisms. In addition. 23 suppliers or clients of the selected panel survey firms were located and interviewed with an extended questionnaire to document their trade-credit activity. contracting patterns, and conflict resolution experience. Finally, 2 textile traders and 5 lumber traders, unrelated to the panel survey firms, were interviewed in the Makola market, and the general lumber market of Accra, respectively. The analysis of the legal and regulatory framework reported here was documented by extensive interviews with most of the formal financial institutions operating in Accra, with officials in public institutions and in the judicial system, as well as individuals in private practice. In all areas of analysis, a comprehensive review of literature, reports and documents was carried out prior to and during our field work in Ghana. The report is organized in two core chapters, and a concluding chapter. The first core chapter presents a critical review of enterprise finance in Ghana, focusing on the characteristics of firm portfolios, the role of informal credit in enterprise finance, and the crucial role of legal and regulatory constraints in credit transactions. The second core chapter reports on a key concern guiding our case-study effort namely, the scope, role and significance of trade credit in enterprise finance. In addition to an extensive literature review on the subject, an in-depth analysis of our findings is presented covering the terms, conditions and motives associated with trade credit transactions, as well as the nature of trade-credit contracts, and the contract enforcement issues that emerge in these transactions. The concluding chapter submits the policy implications we derive from the analysis.  II. ENTERPRISE FINANCE IN GHANA: A CRITICAL ASSESSMENT A. Enterprise Portfolio Choice and Demand for Financial Services Enterprises generate a demand for financial services through their asset portfolio allocation decisions, and their choices of debt instruments, Le., the make up of their liability portfolio. Firms participate in financial markets not exclusively, or even not primarily, to obtain liquidity (to borrow)'! Instead, enterprises resort to financial markets to satisfy a number of requirements, raising ccmital being one of them. Portfolio manaaement QPtions and alternatives which may enhance firm revenues and/or reduce risk exposure, and insurance or insurance substitutes are two major additional motivations to engage in financial transactions. Enterprise portfolio decisions entail the allocation of resources to serve production and investment purposes, as well as risk management choices to protect the firm from insolvency, bankruptcy, and unforeseen adverse shocks. On the asset side, the choice of physical assets over financial assets will signify a preference for firm growth today over potential growth in the future. The decision to invest in industry-specific assets (e.g., an oven) vis a vis equipment of a general nature (e.g., vehicles) represents yet a further commitment to firm expansion, while the opposite may reflect risk aversion or uncertainty about business prospects. On the Jiability side, the decision to borrow, as well as the choice of funding sources represent sequential stages in the implementation of capital-structure cum risk-management decisions. In particular, the idea of a hierarchical preference of internal finance over external finance predicts that profitable, efficient firms will borrow relatively less than other enterprises, since they will finance their expenditures with retained earnings. In contrast, poorly managed firms and enterprises suffering adverse shocks are more likely to acquire debt, and eventually issue equity, to sustain their operations. This section draws upon the findings of the case studies carried out in January 1993 to analyze enterprise portfolio choice among manufacturing enterprises in Accra and Kumasi. Although the total number of manufacturing firms in the data base does not allow a comprehensive statistical analysis of the results, these suggest a number of revealing conclusions and interesting policy implications. 2 The analysis focuses on the characteristics of the liability portfolio documented for the enterprises in the case-study sample. 3 A distinction is made between the sources of funds firms used to finance their recent investment in capital stock, and the general debt portfolio outstanding at the time of the interview, associated primarily with current operating expenses. Throughout the discussion, special attention is given to the nature and diversity of the sources of finance. An important distinction here refers to the relative importance of internal finance, i.e., retained earnings and personal savings, versus external finance i.e., debt and equity issues. In addition the degree 1 Indeed, the pecking order theory of capital structure argues that internal finance, not debt, is the preferred source of firm finance. 2 The data base comprises 44 observations, including five manufacturing firms interviewed as suppliers of panel survey firms. 3 The information collected precludes a detailed discussion of the firms' asset portfolios.  5 of diversification observed in the debt portfolio provides some insights into the degree to which this is used as a risk management mechanism by the firms in the sample. The following propositions guide the analysis presented below: a. On capital structure and debt portfolio composition, enterprises in industries facing relatively favorable market conditions rely relatively more upon their internal resources to finance working capital and investment expenditures than firms in other sectors. In contrast, industries adversely affected by market conditions and liberalization measures, such as textiles/garments and metal works, show relatively high levels of debt and even make use of equity financing; when debt is chosen, trade credit is preferred over bank loans and overdrafts, unless access to bank finance is expeditious and inexpensive. In this respect, differences by firm size are expected to emerge. b. On debt portfolio diversification, small firms, and enterprises under adverse market conditions tend to diversify their sources of finance more than large and successful firms, due to the instabiHty and unreliability the former perceive in their access to their regular creditors. This tendency may be offset by the reluctance of potential sources of funds to provide credit to firms under stress. Admittedly, these propositions assume that firms are able to choose among sources of external funding, with no supply-side restrictions on firms' access to finance. Furthermore, the preference for internal finance relies upon the "safety-first" principle, i.e., that the use of retained earnings does not expose the enterprise to foreclosure by an unsatisfied creditor, or results in relinquishing control by issuing equity. In developing countries, both the presence of credit rationing as well as the existence of benevolent lenders, such as public development banks, may affect the observed composition of firms' portfolios, while not rejecting the "safety-first" principle. Credit rationing tends to depress observed debt levels, while benevolent lenders may induce the opposite effect on enterprise capital structure. These caveats need to be kept in mind when analyzing our findings. 1. Investment in Capital Stock and Sources of Finance Of the 43 firms with valid responses, twenty-seven had made capital investments in capital stock in recent years:' Of these, 14 relied exclusively upon internal sources (retained earnings or personal savings), 4 had bank loans as sole sources of investment capital, and 2 relied exclusively upon supplier credit for their investments. In total, 22 firms used only one source of funding for their capital stock expenditure (2 of them borrowed from relatives or other sources), and the other five combined two sources. This limited degree of diversification is not surprising, since lumpy capital investments are usually associated with specific sources of funds, in spite of fungibility. The low level of diversification in sources of investment funding seems invariant to industry and size. All four sectors and the three firm- size categories show primary reliance on one sole source to finance their capital purchases. 4 Investments in capital stock comprise land, buildings, and equipment. One of the firms had invested but did not report the sources of funds. Investment data could not be combined with those collected in the July survey because the latter did not report investment amounts.  6 The assessment of the relative shares of different sources of funds in financing capitaJ requires consideration of the amounts invested in all three types of capital stock: land, buildings, and equipment. This consolidated assessment is reported in Table 1 for the sectors of concern in this study, and for the entire sample of 43 firms. The sources of finance are classified into three categories: (i) internal funds, primarily retained earnings, and to a lesser extent personal savings; (ii) debt finance comprised by bank loans, supplier credit usually associated with imported equipment, and loans received from relatives and friends; and (iii) equity issues which were reported in only two cases, one a small garment factory receiving contributions from two foreign investors to initiate a rather different line of business, and the other a metaJ work enterprise financing buildings and equipment with a partner's equity contribution. TABLE 1. SOURCES OF FINANCE FOR INVESTMENTS IN CAPITAL STOCK. AVERAGE SHARES IN TOTAL INVESTMENT COSTS, BY INDUSTRY Industry Source of Finance Food Tex.&Gar. Wood Metal An % oftotaJ % of totaJ % of total % of total % of total INTERNAL 70.8 62.5 46.2 50.5 57.5 DEBT 29.2 29.3 53.8 32.8 36.4 Banks 16.7 16.6 28.6 0.0 16.3 Supplier Credit 12.5 0.0 14.3 24.5 11.9 Family/friends 0.0 12.5 10.9 8.3 8.4 EQUITY 0.0 8.2 0.0 16.7 6.1 Source: RPED Case Studies, Ghana 1993. The average shares shown in Table 1 reflect the dominance of internal finance in funding capital investment, in all industries. It must be pointed out that these shares are simple averages of the individual firm shares, without consideration of the different investment amounts per firm. If individual firm shares are weighted by the respective investment amounts the aggregate shares obtained are 17 percent for internal funds, 65 percent for debt, and 18 percent for equity. In other words, the large investments tend to be financed more by external sources than the small projects. The dominance of internal finance across enterprises is consistent with the branch of capital structure theory which predicts that firms prefer internal finance over external finance, and if external finance is sought, debt is preferred to equity issues.!S However, credit rationing by external sources of funds, banks and suppliers, may generate similar empirical findings. This caveat is reinforced by the average shares by firm size reported in Table 2, where small and medium-sized firms still show the dominance of internal finance, while large enterprises finance almost two-thirds of the value of their capital investments with bank borrowing and supplier credit. The latter supports the earlier contention that large investments generate a demand for debt contracts, while additions to capjtaJ stock among small and medium-size firms rely primarily upon retained earnings and personal savings. S See RPED analytical framework for the relevant references.  7 The proposition that depressed industries, with little retained earnings capacity, will use external finance more than successful sectors is only partially supported by the results in Table 1, although textiles and metal are the only sectors where equity issues were reported. Without a comprehensive empirical model of portfolio choice, including the supply side of the debt market, it is impossible to establish causation for the findings reported here. However, two of these findings are highlighted below, given their potential policy implications. TABLE 2. SOURCES OF FINANCE FOR INVESTMENTS IN CAPITAL STOCK. AVERAGES SHARES IN TOTAL INVESTMENT COSTS, BY FIRM SIZE Firm Size" Small Medium Large Source of Finance % of total % of total % of total INTERNAL 65.3 71.7 36.1 DEBT 18.1 28.3 63.9 Banks 3.3 12.5 33.3 Supplier Credit 4.7 0.0 30.6 Family/friends 10.0 15.8 0.0 EQUITY 16.6 0.0 0.0 Source: RPED Case Studies, Ghana 1993. a Firm size by number of employees: Small, 1-10; Medium, 11-50; Large, 51 +. First, bank finance represents at best, among large firms, one-third of total investment expenditures, a finding that disputes the alleged decisiveness of bank credit as a factor in enterprise development. Second, the observed importance of internally generated funds in financing firm growth underscores the relevance of successful day-to-<tay operations as a key factor in enterprise development. The following section analyzes the general debt portfolio of the firms in the sample, encompassing both outstanding balances associated with recent investments and, primarily, obligations supporting current operations. 2. Enterprise Debt Portfolio Perhaps the first remarkable finding in the analysis of enterprise debt is that one-fourth of the manufacturing firms interviewed had no debt of any kind. This proportion shows little variation across industries, but varies substantially across firm sizes. Only one of the 15 small firms had zero debt, while almost one-half of the medium-size firms, and about one-fifth of the large firms reported no outstanding balances. An interpretation of this result is that a good proportion of relatively successful firms in all industries manage to finance their operations solely with their own revenues, without recourse to external finance. The relative importance of internal finance among those firms with outstanding debt, however, is unknown since no figures on total expenditure are available. Overall debt portfolios for the firms with some outstanding debt appeared more diversified than the sources of investment funds discussed above. With up to six possible sources of credit, most firms had current balances with two or three sources, and one firm reported four suppliers of funds. Although  8 no statistical significance can be attached to these results, they do not support the proposition that firms in the troubled sectors (textile & garments and metal works) will show more diversified debt portfolios. Although the textiles and garments sector appears reasonably diversified, the most diversified sector is wood processing, where about 62 percent of the firms had three outstanding sources of finance. The debt portfolio composition of the 33 enterprises with debt in the sample is summarized in Table 3, by industry. The sources of finance are grouped in three categories: (i) banks, including overdrafts and bank loans; (ii) trade credit, where supplier credit (accounts payable), and customer prepayments are detailed separately; and (iii) loans from family and friends, a category that includes other miscellaneous sources reported in only one case. TABLE 3. DEBT PORTFOLIO COMPOSITION, BY INDUSTRy.a AVERAGE SHARES OF SOURCES OF FINANCE IN TOTAL DEBT Industry Source of Finance Food Tex.&Gar. Wood Metal All % of total % of total % of total % of total B~gotal 31 34 13 45 31 TRADE CREDIT 52 50 66 48 54 Suppliers (accts.payable) 37 29 22 9 24 Clients (adv.payments) 15 21 44 40 30 FAMILY & FRIENDS 17 16 21 7 15 Source: RPED Case Studies, Ghana 1993. a Includes only fmns with non-zero debt, N ==33. The average shares reported in Table 3 highlight the significance of trade credit in financing enterprise operations in all sectors. The trends identified in our preliminary report (January 1993) based on the panel data are confirmed in this more accurate measure of portfolio composition. Supplier credit plays a significant role in financing food and textile/garment enterprises, while client advance payments represent a substantial source of funds for wood processing and metal works. Bank finance represents on average less than one-third of firm debt, and shows a more limited participation in sectors deemed relatively successful such as food processing and wood manufacturing, where one can detect a clear preference for business-related debt. It must be pointed out, however, that the connection between most firms and the banking sector may be indirectly through other firms (manufacturing or trading) with direct access to bank finance which pass on bank funds to their business partners as supplier credit or advance payments. 6 A further indication of these inconspicuous links is provided by the strikingly different incidence of bank financing across firm sizes reported in Table 4. 6 These connections are explored further in the section on trade credit below.  9 Although the predominance of trade credit remains clear among small and medium-sized enterprises, the share of bank funding in the portfolio of large firms doubles that of trade credit. Both the incidence of customer prepayments and family loans decrease from small firms to large firms, as strikingly as the relevance of bank finance increases across firm-size categories. TABLE 4. DEBT PORTFOLIO COMPOSITION, BY FIRM SIZE.a AVERAGE SHARES OF SOURCES OF FINANCE IN TOTAL DEBT Firm Sizeb Source of Finance Small Medium Large % of total % of total % of total BANKS 7 24 66 TRADE CREDIT 66 64 32 Suppliers 20 36 21 Clients 46 28 10 FAMILY & 27 12 2 FRIENDS Source: RPED Case Studies, Ghana 1993. a Includes only firms with non-zero debt, N = 33. b Firm size by number of employees: Small, 1-10; Medium, 11-50; Large, 51 +. The contrasting compositions of debt portfolios by firm size portrayed in Table 4 reflect not only the inefficacy of long-standing lending programs targeted to small enterprises through formal banking institutions, but also suggest the futility of firm-size targeting when large firms may be precisely the best conduit to increase liquidity among medium and small-scale firms through trade-credit linkages. As discussed elsewhere, the banks' general reluctance to lend is explained primarily by the incentive structure banks face, where attractive and secure government bonds and money market "investments" favorably compete with firms of unknown (for the banks) credit worthiness. These factors preclude the direct access to bank funding for these enterprises, and in addition constrain the availability of funds for well- established, fully-secured, large bank clients which could otherwise perform the role of intermediaries in connection with their regular commercial activities. Finally, an attempt to address the initial proposition relating sectoral market conditions and debt levels is made in Table 5. In this table, the enterprise debt levels are related to two measures of firm size, number of employees and value of sales, in order to compare relative debt levels across industries. The sectors supposedly more affected by market liberalization, textiles and garments because of the stiff competition by imported finished products and used garments ("white-man dead" clothes), and metal  10 shops because of their reliance on imported inputs to produce for the local market, display the highest per-unit levels of debt. TABLE 5. ENTERPRISE DEBT LEVELS, BY INDUSTRY. SELECTED INDICATORS Industry Item/Indicator Food Tex.&Gar. Wood Metal All Number of firms, rotal 10 14 10 10 44 Avg. N of employees 82 143 65 73 96 Avg. Sales, C'mil. 161 448 70 1423 542 Debt Indicators No.of firms with debt 7 10 8 8 33 Debt/employee, C'OOO 714 1233 598 3545 1529 Debt/sales, percent 11 97 62 68 66 Source: RPED Case Studies, Ghana 1993. The debt per worker among metal manufacturers is almost three times as high as the sector that follows in the ranking of debt-per-worker (textiles and garments). Textiles and garments, in addition to showing high debt per worker, present a remarkable level of debt per unit of sales. Although in a small sample this ratio may be susceptible to outliers, and debt-levels have not been adjusted here for debt maturity this heavy reliance on debt to carry out operations is consistent with the observations in the t field, where garment makers seem to sell little more than their labor to clients that provide most of the materials, and/or advance a large proportion of the final product price upon placing their orders. In summary, our findings tend to support the proposition that industries adversely affected by market conditions and liberalization measures show relatively high levels of debt, given their inability to raise sufficient internal revenues. In all industries, however. internal finance dominates as a source of funds for capital investment, where the low incidence of bank finance questions the alleged decisiveness of bank credit as a factor in enterprise development. The analysis of the general debt portfolio of the firms in the sample highlights the fact that one- fourth of the manufacturing firms in the sample had no debt, although the most of the small firms showed outstanding balances with different creditors. Bank finance represents on average less than one-third of total firm debt, although its incidence is highly and positively correlated to firm size. This finding brings to question the efficacy of loan programs that target small enterprises while neglecting the trade-credit connections that would make funding available to small firms through fully-secured, large firms with direct access to bank loans.  11 B. Enterprise Finance and the Formal Banking Sector' Overdraft facilities As may have been anticipated in a financially underdeveloped economy, large firms are more likely to have overdraft facilities. Only four of 73 small firms had overdrafts, while 11 of 64 medium firms did, and 22 of 36 large firms did. Furthermore, small firms' overdrafts amounted to less than 5% of annual sales, while for large firms the median overdraft was about 8% of annual sales, with a range from 1 to 30%. The vast majority of firms used the full credit line. Of 42 respondents, only one had a dollar overdraft; the remaining were all denominated in cedis. The median rate of interest was 25%, the range being from 1.4% to 42%, with no correlation with firm size. A regression of the overdraft interest rate on the number of employees yielded a coefficient of -0.002 with a standard error of 0.003. Borrowing from formal and semi-formal institutions Of 169 respondents, only 13 said that their firms had obtained a new loan during the last year. Some 19 new loans were acquired, of which five were in dollars, one in pounds, and the rest in cedis. The median cedi loan size was 30 million (about $77,000), while the median dollar loan size was $300,000. The mean size of firms which obtained formal Cedi loans was 95 workers, while the median size was 71. The interest rates on the loans varied from 0% to 90%,8 with a median of 25 % per annum. Table 1. TIME TAKEN FROM APPROVAL TO DISBURSEMENT OF LOANS, GHANA, 199112 Range (months) Time span Median Lower Upper (mo.) Application to approval 2 17 4 Approval to disbursement 0 7 3 Application to disbursement 3 33 7 Only 13 firms answered the series of questions about the most recent institutional loan. The time taken from application to disbursement is presented in Table 1. The median time from application to disbursement was 7 months. The number of meetings required to complete the loan negotiation varied from three to 25, with a mean of 9. It does not seem that for this small and selected sample the application procedures are unnecessarily onerous. The distance to the loan source, however, varied from zero to 304 kilometers, suggesting that for some entrepreneurs the cost of obtaining loans may be very high. No more detail is available on the long-distance cases (230 km, 240 km, 304 km) and it is not clear whether the entrepreneur had to bear the cost of travel over these distances several times, or if there was a branch of the bank close to the firm. We do not have any detail about the loan that took 33 months to come through. Accordingly, the cost of loan negotiations is an issue that awaits further investigation. , This analysis uses the data from the "first wave" panel survey in Ghana, 1992. 8 Why this interest rate is so high is unclear. This should be referred back to Oxford.  12 These loans were paid out in cash; there was no in-kind element. The mean maturity was 750 days. Collateral was required in 10 of 11 cases (the last case having been badly coded). In four cases the collateral took the form of land, and in four cases "other" forms of guarantee were used; equipment and livestock did not serve as collateral in this small sample. The value of the collateral varied from 14% to 500% of the value of the loan, with a median of 200%. It is worth noting that Duggleby et al. (1992) report that bank managers required collateral of60-150% of the loan amount (p. 15). The entrepreneurs who had obtained loans from banks in the past year had known their bank managers for a long time - anything between nine months and twenty years, with a mean of eight years. It is not surprising, then, that only two of the loan recipients had bothered to contact other possible loan sources. The loan application process Of 164 respondents, 29 had made loan applications in the past year (and, as mentioned above, only 13 had succeeded by the time of the interview). They gave various reasons why they had been rejected. 9 128 people who had not applied gave reasons for their decision. A defect in this presentation is that one fairly common answer, namely "I didn't bother applying because I knew I wouldn't get a loan" was not coded and so we are unable at this time to present the number of such responses. 10 The remaining responses are presented in Table 2. Interestingly only four of those who failed to apply in the previous year, and only two of those who had never applied, said that the application process was too difficult. Some 51 out of 128 said that they did not need or did not want loans last year, and therefore did not apply. Since the coding was not complete, we are not yet able to affirm or reject, on the basis of this data set, the standard view that Ghanaian firms were capital-rationed l1 • Table 2. REASONS FOR NOT APPLYING FOR LOANS GHANA, 199112 Reason for not applying for a loan ... last year? ever? N N Have no collateral 9 8 Do not want to incur debt 11 10 Difficult application process 4 2 No need for a loan 40 16 Other 64 38 AJI 128 74 9 These reasons are coded as 1 to 10. There is no legend to the codes in the questionnaire or the codebook. Presumably the codes may be obtained from Oxford. 10 This amendment should be referred back to the Oxford team. 11 For example, as expressed by Duggleby et aI. (1992) that "lack of access to finance has been identified as a primary constraint on the ability of SMEs to adapt and grow" (p. 1). See also para xix, p. vii, op. cit.  13 Deposits in institutions In this sample there was much more activity on the deposit side than there was on the borrowing side. A total of 133 of 172 respondents said that they held accounts at financial institutions; of these, 63 had a single current account, while 55 had multiple accounts. In addition to these, another 53 individuals held one or more savings accounts. 28 entrepreneurs had foreign exchange accounts. Only two of 166 respondents held treasury bills. Eight held deposits in other enterprises, while none held deposit accounts in foreign institutions. C. Informal Credit and Enterprise Finance For the purposes of this report, informal credit is viewed as consisting of credit transactions organized without explicit recourse to the state' s judicial and administrative machinery, or to state-sponsored or supported financial institutions. It excludes, therefore, financial transactions of state and private banks and of diverse regulated non-bank financial intermediaries, such as large finance companies, insurance companies, credit cooperatives, etc.. On the other hand, a significant component of trade credit transactions are part of informal credit arrangements but are dealt with separately in the report. Consequently, informal credit transactions discussed in this section refer essentially to borrowing and lending activities in cash terms. 12 Informal credit appears to play an important role as a source of funds for Ghanaian firms. Additionally, informal loans also constitute a significant component of the uses of funds for some firms, who are lenders. For example, during the course of the case study in January, 1993, it was seen that 9 of the 64 firms (14%) were lending informally. Further, the data in the larger survey indicated that 102 of the 114 firms had been lending in the previous year. The bulk of these transactions were loans to employees -advances on salaries - but even after excluding those transactions, 22 (13 %) firms in the sample were lending informally. However, to the extent that the focus of policy concerns is usually on enhancing ability of firms to satisfy their credit needs, the discussion here also concentrates primarily on the borrowing activities; lending by firms in the sample is included when looking more broadly at the organization of informal financial markets in Ghana. 13 In what follows, the magnitude and scope of informal credit as a source of funds is evaluated in terms of three types of activities: the way firms financed their start-up capital, their most recent acquisition of capital stock and the incidence of informal credit transactions related to working capital requirements. The first two of these reflect demand for credit emanating from investment in fixed capital, that consequently tends to be long term in horizon and thus differs qualitatively from loans catering to short-term working capital requirements. The evaluation of the significance of informal finance is followed by a closer look at the nature of informal credit transactions: their contractual attributes. the 12 The survey also included questions on loans and repayments in kind but only three such transactions were reported; some trade credit transactions can of course be viewed as borrowing in kind and repayment in cash (purchases on credit) or borrowing in cash with repayment in kind (sales on advance payment). 13 The analysis does not include loans made by firms to employees. Further, the information available does not allow differentiation among uses of the loans made by firms: some loans to friends and family may be part of mutual insurance arrangements while others may be used for financing business and working capital needs.  14 sources and uses of informal loans, institutional aspects of informal credit transactions, and an assessment of the role of informal credit in further development of Ghanaian manufacturing sector as also the policy implications. The discussion in this section uses data from the large survey as well as results of the case study undertaken in January, 1993. 14 1. Scope and Extent of Informal Credit Table 1 below shows the sources of start-up capital for firms in the large sample. Figures refer to the average proportions of funds acquired from different sources, for firms classified by size. TABLE 1. SOURCES OF START-UP CAPITAL BY FIRM SIZE ~ Medium Large Own Savings 62 69 47 Loans from 24 9 1 friends/family Loans from bank 0 4 6 Loans from 0 1 0 moneylenders Loans from 12 15 32 other sources Source: Panel survey. Figures are average percent- ages and do not add to 100 due to multiple responses leading to different number of firms each category. Four aspects of these figures are obvious. Firstly, the initial capital for small and medium firms is overwhelmingly from personal savings of the entrepreneurs. Secondly, the role of moneylenders in financing initial capital is virtually non-existent; this is not surprising since moneylenders' operations are usually confined to short-term loans. Thirdly, like the moneylenders, banks also playa minimal role as can be seen from the fact that banks did not provide any start-up funds to the small firms in the sample; in fact, the banks' contribution to initial capital appears minor even for the large firms. Finally, informal loans from friends/family accounted on an average for at least one quarter of the initial capital for small firms and were significant for the medium-sized firms also. It should be noted in this context that most of the loans attributed to 'other sources' are in actuality loans from family members. Consequently, it seems that for firms of all sizes, own savings and loans from friends or family members constituted the primary source for financing the initial capital of the enterprise. The data on start-up capital for firms in Ghana is quite similar to that obtained in some other studies, both in Africa and elsewhere. For example, the African Employment Report (ILO, 1988) reports comparable figures for small enterprises in 10 African countries, not including Ghana: about 65% of the initial capital coming from own savings and virtually all the rest from loans from friends and family (weighted averages). Similarly, a study of metal and small engineering firms in Bangladesh found 65% 14 The terms "large sample", "panel survey", "large survey" are used synonymously to refer to the sample of 174 firms surveyed in June-August, 1992.  15 of initial capital as own savings while 5% was formal loans and the rest loans from friends and families. IS Data on the most recent capital acquisition by firms yields a similar picture on the importance of informal credit for the small and medium firms. For almost 80% of the sample, the last acquisition was purchase of equipment while the for the rest it was purchase of land or building. The table below provides the proportion of firms using different sources of funds towards that end. TABLE 2. SOURCES OF FUNDS FINANCING MOST RE- CENT ACQUISITION (proportion of firms using given source) Source: Small Medium Retained Profits 57 70 68 Own savings 28 23 3 Loans from 23 4 o friends/family Loans from bank 5 12 29 Loans from suppli- 5 2 16 ers Source: Panel survey. Figures have been rounded and do not add up to 100 due to multiple responses. Unlike start-up capital, subsequent investments by the firm can also be financed by means of retained earnings, a category found to be the most important for the firms surveyed in this sample. Once again, the importance of informal sources of funds is also evident for the small enterprises, almost a quarter of which borrowed informally to finance the new acquisition of equipment. At the same time, formal financial sources are more important for large firms and less for small firms: only 3 small firms borrowed from banks while 12 borrowed from friends/family. An alternative way to see the significance of informal credit is to note that, for all firms taken together. about 12 % of the sample used bank loans while 11 % used informal loans from friends/family. Note though that, since the survey did not seek quantitative details on financing of the recent acquisition, these data are incomplete for two reasons. Firstly. the significance of informal credit relative to formal does not take into account the fact that the average size of the bank loans is presumably higher than that of informal loans. Secondly, the figures do not differentiate between, say, a firm borrowing from friends/family to finance 10% of the investment and another that finances all of the investment through informal borrowing. Finally, another indication of the importance of informal loans to small and medium firms is provided in Table 3 below which shows the number of firms that received informal and formal loans and overdraft facilities during 1992. A total of 55 firms in the whole sample responded as having borrowed informally. Again, informal loans constitute an important source of finance for small and medium firms while banks' lending is almost non-existent for them; only 3 small firms had access to overdraft facilities IS Bhattacharya(1988). Similar findings on the dominance of own savings are reported for 310 registered firms in India by Thangamuthu and Iyyampillai(1983).  16 with formal banks. 16 Quantitative unimportance of small and medium-firm financing by banks is also evident from the fact that nine small firms had applied for formal loans in this period, and none of the applications were approved while only seven of the fifteen applications of medium-sized firms were approved. In contrast, none of the applications for formal loans by the large firms were turned down. TABLE 3. AVAILABILITY OF FORMAL AND INFORMAL LOANS BY FIRM SIZE Overdraft Formal Informal facility loan loan Small 3 0 30 (4) (0) (43) Medium 12 7 20 (18) (11) (31) Large 22 6 5 (60) (17) (14) Source: Panel survey. Figures are numbers (percentages) of firms in the large sample reporting use of source dur- ing preceding one year. Surprisingly, the survey data show that almost as many large firms received informal loans as received formal loans. Informal loans are typically transactions undertaken between individuals rather than corporate entities: participants in informal credit transactions are most likely to be associated with unincorporated, owner operated enterprises. Indeed, among the 55 firms reported in the table above, only 1 small firm (out of 30) and 5 medium-sized firm (out of 20) were incorporated with all others being either sole proprietorships or partnerships; all five large firms were incorporated entities. Consequently, the informal credit transactions of large firms should be viewed cautiously. This also finds support in results of the January survey which indicate that the informal transactions of large firms can turn out to be quite atypical and, in one case at least, rather spurious on closer inspection. Thus, a total of 20 out of the 64 firms in the January survey reported at least one informal loan during 1992; some had borrowed more often than once. 11 of these firms belonged to the sample of the larger survey and seven of them were small while two each were medium and large-sized firms. In case of one of the large firms reporting informal borrowing, the loans were essentially transfers from the foreign owner of the firm (70% of the equity was foreign owned) who paid out of his own pocket to expedite imports from his country and was subsequently compensated by the firm. Similarly, the informal borrowing of the other large firm consists of deposits that are required from all customers; in order to be able to purchase from this firm, the customers pay a deposit and then purchase either on cash basis or on very short credit (up to a week) with post-dated checks. 17 Another related example, 16 Note that the figures for formal loans refer to firms that had received loans in the previous year only and are consquently underestimates with respect to availability of formal loans from banks. For example, some firms may not have received loans in the previous year because they already had too high a debt from previous years. The bias is obviously more for the larger firms than the smaller ones, but is not significantly large in any category_ 17 The firm can demand such unusual arrangements presumably because the products are quite profitable for the customers, who are almost entirely wholesalers and retailers of the firm's product.  17 identified during the case study, was of a large firm's informal lending that turned out to be inter-firm transfers by the owner among his different enterprises. Whether or not the arrangements described above are viewed as informal credit transactions, surely they are not representative of the arrangements and constraints associated with small and medium firms, whose informal borrowings display considerable similarities in qualitative terms. Given these considerations, and that only 5 large firms in the panel survey reported borrowing informally, the discussion of informal credit transactions below deemphasizes transactions of the large firms. 18 2. Sources and Uses ofInformal Credit Friends and family members constitute the dominant source of informal loans for the enterprises. Data on source of informal loans is available for 51 of the firms that reported borrowing in the large survey. Apart from one small firm borrowing from an informal group, virtually all others had borrowed from friends or family (f/f): 45 identified flf explicitly as the source while 5 listed 'other' sources some of which again may be viewed as overlapping with the flf category. The dominance of flf as source of informal loans is not in the least surprising: other studies in different countries have also found similar results. A major reason underlying the dominance of flf as a source of informal credit is that the category is quite wide in its coverage and may include diverse people, ranging from family and close friends to neighbors, colleagues, people from same geographical origin, etc.. Some indirect evidence indicating the possibility of this diversity in the present sample is provided by the fact that of 43 recorded responses in the panel survey, 15 borrowers had attempted to borrow from at least one other source than the one they actually obtained credit from. In addition, one of the respondents borrowing from flf had to provide collateral while four others had to fulfil other conditions, such as third-party guarantees and use of witnesses, attributes not frequently associated with informal loans among close individuals. However, the majority of loans do seem to be from close family members: during the January survey, we collected data on source, differentiating between friends and family members, and found only two small or medium-sized firm that did not borrow from a close relative (excluding five trading firms that are discussed later). A remarkable feature of the Ghanaian manufacturing enterprises surveyed is the virtual absence of loans from moneylenders, even for working capital purposes. It is possible that loans from moneylenders may get disguised as emanating from friends but, as is discussed later, the interest rates charged on the observed loans would discredit that possibility in the present case. While it would be quite difficult to make claim that moneylenders do not operate in Ghana, the evidence would indicate that their role may be confined to agriculture and services sector although, with respect to the latter, interviews with eight traders and wholesalers in the January survey also failed to indicate any use of moneylenders as a norm. Recall in this context that the number of moneylenders operating officially in the Greater Accra region has declined continuously, from 33 in 1972 to 4 in 1988 and only 2 in 1992. While much has been said about the usurious role of moneylenders, their absence can also be a cause of concern if it indicates, for example, non-viability of informal credit markets due to problems of clearly defined property rights and enforcement: these are widely understood to be prerequisites to well organized market exchange. 18 Needless to say, this does not imply that entrepreneurs owning large firms do not participate in informal credit markets. The contrary in fact is more likely to be true if one looks at data from Asian countries. However, those transactions have not been picked up by the available data.  18 Another important finding yielded by the data is the limited role of ~ as providers of short-term credit: only one firm in the panel survey had borrowed from an informal club. This finding conforms to those reported in some other studies noted in an earlier section. Some of these studies have also noted that the ~ playa similarly minimal role in savings mobilization from small manufacturing enterprises; this is found to hold in this sample irrespective of firm size. 19 The minor role of ~ has been attributed to their being constrained in lending due to structural impediments to maturity transformation of their liabilities. Consequently, a policy recommendation to overcome these impediments has been to provide ~ with greater access to funds, enhancing their liquidity, thereby freeing up some of their deposits for 10ans.20 However, looking at the broader picture yielded by the results above, wherein neither moneylenders nor ~ play significant roles, and informal borrowing is confined to close friends or families, it seems legitimate to speculate whether problems deeper than absence of liquidity underlie the observed structure of the informal financial sector in Ghana. In particular, the possible absence of informal credit markets suggests structural impediments, i.e., costs of transaction high enough to prevent the markets from being organized. In Ghana, the findings suggest, it is not just banks that are precluded from lending to small and medium firms, because of high transaction costs, but also, in principle, the informal intermediaries. This aspect has important policy implications which are discussed later in the report. The survey did not ask firms to describe the purposes underlying informal borrowing. However, that informal loans are typically undertaken to finance working-capital needs is commonly seen in other countries, and the short duration of many informal credit transactions in Ghana is also consistent with their serving that purpose. Excluding informal loans of the five large firms, data on maturity of loans are avaiJable for 34 loan transactions. The maturity of 7 of them is up to two weeks while a total of 14 (41 %) loans have a maturity of up to one month. Interestingly, however, there is also some direct and indirect evidence indicating that the informal credit transactions picked up in the survey are not confined to working capital alone, but are also used to finance fixed capital in the form of equipment or purchase ofland or building. The indirect evidence stems from the fact that more than half the loans have maturity in excess of three months as is shown in the table below: the distribution of maturity of informal loans is strongly bimodal. 21 19 Women doing petty trading and retailing have been found to be much more active users of susus, (Aryeetey and GockeJ(1991». 20 Duggleby et. al. (1992). 21 Duration for six loans borrowed by firms in the sample was coded as non-existent. However, in supplemental notes, three of them specified that repayment could take as long as necessary: one respondent, for example, had bought machinery with the loan (borrowed from her father) and had been unable to repay due to inadequate sales. Consequently, the loan duration was being considered open ended by both lender and borrower. All six, including three others with the same code (but no notes), have been included as loans with duration more than 90 days.  19 TABLE 4. DURATION OF INFORMAL LOANS LOANS BORROWED LOANS MADE Dyration Freguen",X Cumylative Fr~uencx Cumulative (Days) Pen,~nt Per~ent 1-30 14 41.2 12 75.0 31-60 2 47.1 1 81.3 61-90 2 52.9 0 81.3 > 90 16 100 3 100 Source: Panel survey. Five loans of large firms excluded. Thus, 14 of the 32 loans received by the firms are less than a month in duration while 16 have duration exceeding 3 months. Loans made by the firms, on the other hand, are predominantly short term, up to a month in duration. To the extent loans to fmance fixed capital would be associated with longer duration, the figures above suggest approximately half the transactions as directed towards fulfilling working capital requirements and the other half catering to investments in fixed assets. 2Z These figures are also consistent with the data presented earlier regarding the role of informal credit in financing of the last capital acquisition by firms. The direct evidence follows from more detailed questioning undertaken during the case study. Two of the 9 small and medium firms that had borrowed informally, and were also members of the earlier panel survey, indicated specifically that the loans were supporting investments in fixed assets. One entrepreneur had borrowed 1.8m cedis from his father and purchased land in October 1992. (Interestingly, he had also borrowed recently from someone else the same amount to repay his father's loan). The other entrepreneur was quite active in informal finance: he had borrowed almost 750,000 cedis from his uncle that he had paid off by the time of the interview when he was owing 250,000 cedis that he had borrowed from two friends. He was moving to a new site and had been using these loans for the purchase of a building. (Here too it is possible that the borrower was borrowing to repay earlier loans, or at least parts of them). 3. Contracts, Institutions and Markets in Informal Finance Contradual attributes of informal credit transadions It is increasingly recognized that institutions exert a powerful impact on the way economic activity is organized and hence on economic outcomes. Even well developed markets in industrialized countries rest upon complex institutional structures, e.g., elaborately defined and effectively enforced property rights, formal contracts and guarantees, limited liability, bankruptcy laws, etc.. Both strands of New Institutional Economics, one associated with the work of authors such as Alchian, Demsetz and Williamson and the other with the imperfect information paradigm, as in the works of Akerlof and 2Z The duration of loans for those not coded as 'non-existent' but exceeding 90 days varies from 3 loans with maturity of 120 days to 4 with maturity of 1 year to 1 with 18 months' duration.  20 Stiglitz, focus on the role of transactions costs as determinants of institutions. 23 The latter, however, focuses primarily on imperfect and asymmetric information as affecting the institutional structure: what the transacting parties know and do not know determines systematically the arrangements that will characterize exchange between them. Consequently, a basic premise underlying empirical methodology in this framework is that the transacting environment of economic agents - in terms of informational structure, risks, enforcement, and other elements of transaction costs - can be inferred indirectly from the contractual forms. In looking at the nature of the informal financial sector in Ghana, an analysis of the contractual attributes of informal credit transactions can shed some light on important issues such as the information structure underlying these transactions, the extent and ways that participants mitigate problems of adverse selection and moral hazard, nature and extent of risk sharing, search and negotiation mechanisms in credit markets, etc .. Looking first at the issue of collateral, there is virtually no role for it in the informal credit transactions recorded in Ghana. Analysis of the data on informal borrowing reveals that only one loan out of 50 had utilized collateral. At the same time, of the 20 firms that had given informal loans, not one reported the use of collateral. Collateral is often viewed as an outcome of pre-contractual information asymmetry. Although presence of use of collateral by itself is neither necessary nor sufficient to indicate presence of specific informational asymmetries among participants, a systematic pattern of absence of contractual mechanisms used to ameliorate problems of adverse selection or moral hazard may provide more robust clues. Thus; another observable consequence of pre-contractual informational asymmetry is the presence of a menu of credit contracts, in terms of interest rates-loan size combinations or combinations of interest rates, collateral and loan amounts; these could be the outcome of screening on part of lenders facing observationally identical borrowers. Data on interest rates and loan amounts does not bear out such diversity in the Ghanaian case: for firms that were lending, the amounts range from 1000 cedis to as much as 40m cedis, while the interest rates for all reporting firms (19 out of 20) in the large sample are identically equal to zero. Similarly, for 49 (out of 51) firms reporting interest rates on informal borrowing, only 5 report positive interest rates ranging from 10 to 25% (not standardized for the varying durations) while the nominal interest rates for the other 44 loans are also identically zero. The fact that the interest rates are all zero may not have much direct bearing on informational aspects but may instead be attributed to absence of market forms of exchange (as is done later in the analysis). However, some further evidence supporting the possible absence of severe informational asymmetries in informal credit transactions is provided by the observed relationship between borrowers and lenders. It has already been documented that the overwhelming source of informal borrowing for the firms is the category of friends and relatives, which is also dominant as a recipient for firms making informal loans. The table below provides data on the length of time the borrowers and lenders have known one another (according to the partner sampled in the survey). 23 See Bardhan(1989) for extensive references. The RPED document of January 1992 provides more detailed explanation of the links between contract structures, transaction costs and RPED hypotheses.  21 TABLE 5. LENGTH OF RELATlONSHIP BETWEEN BOR- ROWERS AND LENDERS LEN~TH LOANS ~IVEN LOANS RECEIVED (Years) Cumulative Cumulative Frequency Percent Frequency Percent 0-5 7 38.9 11 24.4 6-10 2 50.0 7 40.0 11-20 2 61.1 11 64.4 21-40 7 100.0 10 86.7 41-52 6 100.0 Source: Panel survey. As can be seen, the median length of time participants have known each other is 20 years for loans made by firms while the same for loans received by firms in the sample is 26 years. In the latter case, almost 75% of the transactions are between individuals who know each other for at least 5 years; similarly, about 60% of the firms lending informally knew the recipient for 5 or more years. Further, the respondents were also asked about the geographical distance between them and the credit partner, and of the 37 available responses, almost 80% were located within 5 kilometres of the other party. A final aspect of the data relevant to the informational structure underlying informal credit transactions is the mode of repayment of loans. Again, the larger survey did not collect data on whether or not repayment of loans was contractually specified at the time the loan was transacted. However, observations during the course of the I anuary survey provide indirect but compell ing evidence that indeed the mode of repayment is quite flexible, i.e., state contingent. The numerous trade-credit arrangements documented in that survey invariably reflected absence of standardized contracts and fixed schedules of repayment. The most common arrangement was characterized by repayments depending upon sales and or liquidity of the borrowing firm ( and occasionally the lending firm): the attribute common across the diverse transactions was that new credit would not be granted till the previous one had been substantively repaid. For example, in response to questions probing the reaction of firms to delays in payment by parties borrowing trade credit from them, all but three of the 50 firms responding in the January sample indicated they would extend the term of the contract: delays in repayment would result mostly in repeated but patient requests for payment. Given the pervasiveness of flexible contractual arrangements in trade credit, it is reasonable to extend them to other informal credit transactions also; only five firms responded to what actions they would undertake in case of delays in repayment of loans, and all indicated the same response as in trade credit arrangements, namely. extend the duration of the loan until such time as it was repaid. Such flexibiHty of contractual arrangements, both in terms of the installments of payments as well as the total time entailed, is indicative of full-information state contingent contracting between the firms or individuals and would again suggest extensive flows of information between the parties in order to ameliorate problems of moral hazard. Informal credit and informal credit markets in Ghana The contractual attributes of informal credit transactions in the sample are not inconsistent with the view that these loans are typically undertaken among groups that are small enough and proximate enough that they can exchange extensive information, allowing flexibility of arrangements at costs of transacting much lower than would be feasible with formal, institutionalized entities. To that extent,  22 informal finance in Ghana shows some qualitatively similarities to the large and active urban informal credit markets in many Asian economies.24 At the same time, however, notwithstanding the significant incidence and importance of informal financial transactions in Ghana, the findings of the present study also lead to a suspicion that the organization of these informal credit activities should not be viewed as constituting a well developed financial market. Needless to say, arrangements underlying informal credit transactions show considerable variation in most countries, leading some to skepticism regarding the ubiquity of the market form of exchange, (Bardhan(l989»; other researchers in Asian context have also questioned whether some of the observed credit arrangements could be called markets (Tun Wai (1980».~ In the case of Ghana, the overwhelming dominance of family relatives and friends as both source and recipients of informal borrowing, the virtual non-existence of moneylenders and other intermediaries (such as small finance companies, brokers, etc.), absence of transactions with nominally positive interest charges, and the relatively high proportion of transactions seemingly geared (in terms of duration) towards fixed-capital formation rather than working-capital needs, taken together, seem inconsistent with the presence of any organized market forms underlying the observed informal financial transactions . Two important caveats, however, are entailed here. Firstly, informal credit is not always very visible and this possibility, however remote, may have affected the information obtained both in the large sample and the January survey. It is also possible that credit activities have subsided in recent years due to economic fluctuations induced by introduction of major structural adjustment policies. During the January survey, for example, a number of firms indicated that they used to provide (trade) credit earlier but had stopped doing so now because of worsening problems in collecting debts. Secondly, the preponderance of credit transactions outside a market form of exchange does not imply that the potential for well developed informal credit markets is non-existent. In addition to the fact that credit markets may have been far more active at other times, the focus of the study was on manufacturing firms. However, informal credit markets are generally more active amongst trading groups than manufacturing, as was bome out by interviews with eight wholesalers and retailers in the January survey. Since the traders are discussed more in sector-specific portions of the report, in this sub-section an example of a wholesaler'S activities is given, along with another (manufacturing) firm whose informal transactions could be representative of those in any well developed informal credit market. The objective of the examples is to indicate the form that the identifiably market-type exchange for credit takes in Ghana. Case #1: A wholesaler for textiles in Makola market for 5 years, this entrepreneur purchases all her textiles domestically. There are only 8 wholesalers like her (in terms of size) in the market; however,. she is unable to buy on credit from any of the 6 domestic manufacturers. So despite buying from the same manufacturer for 5' years, her purchases are entirely in cash. Further, she has to purchase every week in order to maintain her access to the manufacturer, i.e., receive her allocation. 24 See, for example, Ghate(1988). ~ The scope of the present analysis precludes semantic discussion of the the term "market". Informal credit markets are rarely organized as a typical textbook market wherein "anonymous participants trade a standardized contract such that each unit of the contract is a perfect substitute for any other unit", (Telser and Higinbotham(1977». While any exchange between any two individuals can be viewed as constituting a market, the discussion here refers to the presence or absence of credit markets with some reasonable depth, in terms of number of participants involved, that are organized on the premise of exchange on a commercial basis.  23 All her clients are retailers in the same market and hence in close proximity. She frequently sells the goods on credit but also indulges in very active credit and debit transactions with her clients. The goods move very fast, and so the duration of loans is quite short. She may borrow from clients for a few days and repay them in goods; on other occasions she may grant them credit in tum. She has 8 friends in other lines of business (but apparently with close ethnic affinity) from whom she can borrow at very short notice. Her claim was she could raise up to 100m cedis in this manner although she generally uses only a small proportion of this "goodwill" capital. Case #2: Small firm in metal working sector with 6 workers. The firm purchases all raw materials on cash basis and finances its working capital through advance payments by clients and informal loans. The entrepreneur has two reliable sources of informal loans: his sister, who is a trader, importing from Togo, and a friend. He has borrowed from them 14 times in 1992 for periods ranging from 45-90 days. At the time of the interview he had outstanding debits with them of 1.725 m cedis. The sister charges him an interest rate of 5 % per month which is her opportunity cost of funds while his friend lends to him against confirmed purchase orders at the rate of 10% per month. D. The Legal and Regulatory System and Enterprise Finance The formal financial system of Ghana is comprised by nine govemment-owned or government- controlled banks under varying levels of financial stress, three private banks (with minor government participation), a recently founded private merchant bank (Continental Acceptances), and a discount house (Security Discounts, a subsidiary of Continental).26 In addition, there are several insurance companies, and a large network of failing, donor-dependent rural banks. Operating in a fairly liberalized regulatory environment since 1989, the formal banking sector has steadily increased its lending to the manufacturing sector during the last decade. However, access to bank credit by small-scale enterprises has been an issue repeatedly raised by numerous studies as a major constraint to industrial growth. Apart from a basic imbalance in the incentive structure faced by banks, discussed elsewhere in this report and usually ignored by analysts, a common explanation for the alleged lack of access to bank loans by small and medium-scale enterprises is their inability to pledge acceptable, enforceable collateral. In addition, problems and costs associated with contract enforcement are hypothesized to influence the willingness of formal financial institutions to serve borrower classes where these problems and costs are perceived to be substantial. This section presents first an in-depth analysis of the collateral issue, focusing on the role of land ownership and land-transfer regulations in facilitating, or impeding, the performance of loan contracts. Subsequently, a brief discussion of partial data on bank portfolios provides some insights into their policies and preferences towards different types of collateral. Finally, a thorough analysis of the constraints on debt collection and enforcement concludes the section. 1. The Role of Land Ownership and Transfer Regulations Ownership of real property in Ghana falls under three general categories: government-owned, stool- (or tribal community) and family-owned, and individually-owned. Government land is leased to 26 See the RPED Country Background Paper, July 1992. The number of banks has increased by one since that report with the creation of Meridien BIAO-Ghana. Continental Acceptances also started operations after July 1992.  24 tenants, whereas' stool and family land may be leased or otherwise partially alienated. (Subsequent references to transfers of government or stool land usually refer to leases.) Individually-owned land is held exclusively by one person and is freely a1ienable. 27 The current system of land ownership and transfer regulations clearly retards, and to some extent limits, access to formal credit. First, due to lack of clear title to much usable land in Ghana, there is a limited amount of real property that can be put up as collateral. Second, a government embargo on the transfer of stool and family land has further restricted land available for collateral. Finally, where title or leases are clear and alienable, transfer regulations needlessly delay the formalizing of mortgages and, consequently, access to borrowed capital. Each of these points is clarified below. a. Due to lack or clear title to much usable land in Ghana, there is a limited amount or real property that can be put up as collateral. Universally, banks prefer to lend to enterprises that can provide collateral sufficient to cover the bank's exposure.28 In Ghana, it is not uncommon for private loans to medium and large enterprises to be secured up to 300% - 500% of their value.29 In contrast, loans from the state-owned Ghana Commercial Bank need oruy be collateralized up to 133% of the loan (with real property) and 167% (with equipment). Both public and private banks prefer to lend against real property (land and buildings) over moveable property, not only because it is usually the most valuable asset belonging to a firm, but also because it tends to be the most sure way to secure a loan, mainly because it does not depreciate rapidly, can be easily identified, and is difficult to move or hide. Real property has value as collateral only if the lender can establish a flawless legal claim to it in the event the borrower defaults; thus, where competing claims (actual or potential) threaten the certainty of title, that property will not be acceptable collateral. In Ghana, interests in real property are complicated, due to the tradition of communal ownership. The rights to various claimants within an ownership community are complex and unclear. Ownership rights are complex because they are not exclusive; regardless of the amount of time, effort, and capital one invests into a property, other members of the stool or family (including future generations) have legal claims to the property and the benefits therefrom. Similarly, these legal claims complicate the determination of who is empowered to convey property interests. The rights of claimants are unclear because they are based on customary law, which 27 Apparently no official figures exist on the distribution of land ownership in greater Accra and estimates vary widely. Everyone agrees that there are very few individual freeholds, amounting to possibly 5-10%. Some indicate that the government owns 10% of the remaining land, leaving the rest to stool ownership. Others believe the government owns most land in and around Accra. Regardless of ownership, it is clear that the government does control the final disposition of most of the land in greater Accra, in that government permission is required before alienation (discussed in detail below). 28 A bank's exposure may be roughly calculated as the collateral's value at the time of the security interest - depreciation at the time of foreclosure - the costs of foreclosure and sale. 29 Such high ratios even apply to apparently prosperous firms, which indicates the high risk perceived by lenders. For example, one such firm, requiring 500% collateralization for its overdraft, is a successful producer of furniture, who supplies large corporate and government agencies in Ghana. In contrast, collateral for small- and micro-enterprises ranges from 60% to 150% of the loan amount. T. Duggleby, E. Aryeetey, and W. Steel, "Formal and Informal Finance for Small Enterprises in Ghana, Industry Series Paper No. 61, The World Bank, August 1992, p. 15.  25 is unwritten and heavily influenced by equity considerations. In addition, transfers of interests are not documented, thereby exacerbating uncertainty.30 As a result of the heightened risk of competing claims on mortgaged property, banks will only lend against property that is surveyed, plotted, and registered at the Land Title Registry. In most market economies, the purpose of a title registry is to provide a definitive record of interests31 in land in order for others to rely on that information. Put simply, whoever is recorded as owning a property interest is, by law, the owner. The reliability of such information is essential for reducing risks in transacting. Under the Land Title Registration Act of 1986,32 every existing interest in Ghanaian land is to be recorded. The initiative was intended to stem litigation, which often arose due to the absence of accurate maps identifying plot boundaries and the absence of documentation that people had rights to land that they claimed they had. In this sense, the act was intended to be a reliable factual record of various interests in land. However, the act fails to reduce the risk of transactions because the interests that are recorded are interests as they exist under customary law. In other words, communities (stools and famities) are to be registered as proprietors of their vested interests and customary rules requiring consensus of various community members are to remain unaffected. 33 This means it is possible for community members to challenge transfers of property on the grounds they did not consent. While customary Jaw does provide mechanisms by which to resolve such disputes, these provisions create rent-seeking opportunities by those who seek to prolong litigation in hopes of earning some sort of "greenmail" as placation. The foregoing problems affect stool and family property. In contrast, leaseholds on government- owned land are considered secure forms of loan collateral. This is because government land is not subject to valid competing claims of others.:l4 All the industrial zones around Accra are government- owned, meaning that industrial firms that seek loans will already occupy government land; thus, they will 30 Note, this also creates great opportunities for stool chiefs to extract rents from tenants. For example, non-stool members (or "strangers") are sometimes sold interests in stool land by a chief, usually for farming purposes. When that chief dies, the successor chief may disclaim knowledge of the transaction and seek additional payment from the tenant. Similarly, farmers have been known to buy usufructuary rights from the stool chief and to cultivate the land, only to be subsequently confronted by another person with documents of title to the same piece of land granted or sold to him by a previous chief of the same stool. Memorandum, Land Title Registration Law, p. 1. While these problems have been predominant with agricultural land, they have the potential to inhibit growth in the commercial and industrial sectors as well. 31 Interests includes all rights and claims, including, among others, freeholds, leaseholds, usufructs, and mortgages. 32P. N. D. C. L. 152 (1986). For a detailed review of this law, see Gordon R. Woodman, "Land Title Registration Without Prejudice: The Ghana Land Title Registration Law, 1986, 31 Journal of African II Law 119 (1988). 33 Land Title Registration Act, sections 93(2) and 110. :l4 Land acquired by the government, by either expropriation (in the late 1970s and early 80s) or eminent domain (compulsory acquisition), which requires proper compensation, carries clean title. Where no compensation has been paid, clean title is not conveyed. This has tied up large tracts of valuable land in greater Accra.  26 not face this initial constraint. Other enterprises, however, that operate outside of industrial zones are not necessarily on government land, potentially reducing their chances of securing adequate financing. The second most secure land is individual freehold land that is registered at the Land Title Registry. This is secure because the individual that owns it does not have to seek permission of anyone else before alienating it, leaving no possibility for valid competing claims. In the event there is a competing claim, the title document itself will determine the valid owner. This kind of title is valuable as collateral, not only to enterprises not requiring industrially-zoned land, but also anyone seeking to mortgage his or her residence to finance an enterprise. The remaining land, namely stool-owned and family-owned, is considered too risky to accept as collateral, as was explained above. Even stool land that has been plotted and registered, and whose tenant has filed the properly signed title, is vulnerable to challenge. Although the Land Title Registration Law provides that newly registered titles are not contestable,35 competing claims still arise, which, regardless of their validity, are still costly enough for bankers to avoid this property. Most stool and family land is residential. This imposes serious limitations on entrepreneurs who seek to mortgage their property, either residential or commercial, to finance a venture or supplement financing thereto. b. The current embargo on the transfer or stool and family land further restricts land available for coUateral. Both competing claims and lack of clear authority to alienate property has led to much litigation and, consequently, has slowed building and land development. In addition, throughout the 1980s stool chiefs had fraudulently transferred interests in land by selling the same parcel to three or four unknowing buyers. In an effort to stem the increasingly unstable market for real property and to protect potential victims of fraud by chiefs, the government imposed an embargo on transferring interests in stool and family property in 1989, possibly amounting to about 60-80% of the land in greater Accra. While this embargo is in effect, purchases of stool or family property (and leasehold interests therein) are at a standstill. Similarly, mortgages cannot be taken on this land until the embargo is lifted, thereby restricting access to home, commercial, and industrial finance. It is rumored that the embargo will be lifted soon. However, it is not clear that land law or policy changes have been made to stabilize title to this land once the embargo is lifted. Much stool land is not yet registered, making title searches impossible. "Asking around" about competing claims on land is expected for buyers, but this kind of search is imperfect for both the buyer and for arbiters of possible future disputes. On the enforcement side, courts seem hesitant to enforce anti-fraud measures against chiefs. In the rare cases that courts award compensatory damages to defrauded buyers, chiefs often have already spent the money and therefore cannot pay. Granting substitute parcels of land sometimes occurs, but this is less satisfactory, since land is by definition a unique good. The current initiative to plot and register title to all land in Ghana should help remedy this. Work in this area is proceeding Slowly, and only a fraction of land (mostly urban) has been surveyed and plotted. Even where land is surveyed and plotted, however, many Ghanaians fail to register their titles due to a misperception of its relevance. It is hoped that over time people will become accustomed to 35 According to an official announcement of the Land Title Registry, "all previously registered deeds ... are being replaced by Land Certificates .... The Land Certificate is final and conclusive in the sense that it is a complete answer to all adverse claims in the Courts and may be deposited with a Bank as security for a loan in a cheap and expeditious manner for farming, housing. and commercial purposes." The Weekly Spectator, No. 1276, Saturday, September 5, 1992, p. 4.  27 registering transfers of title. Until then, before lifting the embargo, the government should accelerate the land registration process, so as to increase the number of secure titles in Ghana. District Land Registries are currently scheduled to open after greater Accra is plotted. 36 Ghanaian industry would benefit by implementing this plan sooner rather than later. c. Where title or lease hold interests are clear and alienable, transfer regulations needlessly delay the formalizing of mortgages and, consequently, access to borrowed capital. Today, control over most land in Ghana is highly centralized in the Lands Commission. While individual freehold interests in land are freely alienable, given the consent of the owner of record, transfers of interests (including mortgages) in government land and stool or family land require the consent of the Lands Commission. Consent for the transfer of these lands takes from three months to one year to be granted. Neither of these time periods is reasonable, and they delay access to badly needed investment capital. Under Ghanaian law, a mortgage is not fully secured until government consent is obtained; thus, lenders tend not to release borrowed funds until they have this consent.37 This unnecessarily delays the growth of private business and subjects the business to inflation risks and currency devaluation. Two rationales were given for this requirement. The first is government's monitoring of rent. With regard to government land, the consent requirement gives the Lands Commission the opportunity to determine whether or not tenants of government land have paid their rent. According to an employee of the Lands Department (who is not involved in the approval process), if everything is in order, this approval should take two weeks. The only reason for delays would be the borrower's unwillingness or inability to meet his or her rent obligations. The process is supposedly as follows: an application for consent arrives at the Lands Commission; the file belonging to the holder of that lease is checked for current rent obligations; if rent is owed, a clerk at the Lands Commission sends a letter to the applicant, stating the amount of rent due and instructing the applicant to pay it;38 if and when the rent is fully paid, the application is considered by a special committee, which meets biweekly for that purpose. At this point, consent is granted. While it may be that the government is justified in ensuring its tenants pay their rent, this mechanism is highly inefficient. Not only does it needlessly hinder the markets for real estate and credit, but also it is not an efficient way to coHect rent, which should be monitored month to month. If records are such that rent history can be checked within two weeks, then it would seem that the Lands Commission is organized sufficiently enough to identify more promptly lessees who are in arrears. With regard to stool land, government consent allows the Lands Commission to review the rent charged by stools for their leases. If the Commission finds the rent is too low, it may increase the rent upon granting its approval to alienate. 36 Sites include Kumasi, Sekondiffakoradi, Cape Coast, Koforidua, Sunyani, Ho, Tamale, Navrongo, and Bolgatanga. 37 It became apparent in interviews, however, that many lenders will sometimes allow the borrower to draw down on borrowed funds before consent is given. However, this is only for established, privileged borrowers and does not apply to new entrants. 38 It is most likely this step that causes the longest delays.  28 The second possible rationale for government consent is assumed to be the prevention of speculative buying or leasing of land. However, since requests for permission to alienate are apparently never denied, it would seem there has been no attempt by one buyer to acquire interests in large estates. Furthermore, the government could monitor large acquisitions without delaying transactions, as transactions recorded on land titles are matters of public record. Regardless of the government's rationale, this requirement imposes costs on both lenders and borrowers. Both lenders and borrowers must constantly shepherd their requests for consent through the Lands Commission; otherwise the application may become "lost. "39 This takes a great deal of time and significantly reduces marginal gains for both lenders and borrowing entrepreneurs. These costs are particularly high for medium-scale businesses. While this alone may not be a deterrent to lending and borrowing altogether, it may indeed influence 1) where loans are going, i.e. to larger, foreign companies (who may not even need collateral to secure loans), or 2) who seeks loans at all, i.e. it may drive otherwise profitable entrepreneurs to lower cost (or sub-optimal) investments. The government should either expedite this consent procedure or preferably abolish it altogether. 2. Analysis of Banks' Portfolios by Type of Security Four banks agreed to answer our questionnaire on the types of collateral securing their current loan and overdraft portfolio. 40 Table 1 through 3 compile their responses for the entire portfolio, Table 1, and for the manufacture and commerce sectors, Tables 2 and 3. The figures from banks 1, 3 and 4 include overdrafts and loans, whereas bank 2's figures reflect primarily overdrafts, as they currently limit their lending to overdraft facilities (the bank has been in operation for only six months). Although the data collected is somewhat limited in detail, it does roughly reflect the banks' preferences for different types ofloan collateral. In the first two banks, loans and overdrafts secured with fixed property dominate the portfolio of the banks. Bank 3, which did not provide a classification for the entire portfolio, indicates a dominance of fixed property collateral among loans to commerce, but a prevalence (in terms of outstanding balances) of "unsecured" loans in the manufacturing sector which, we suspect, are accounted for by a few large overdraft facilities to large manufacturers with headquarters abroad. When the number of loans in manufacture is considered, however, the preference for fixed property collateral is also apparent for this bank. Bank 4 shows a relative majority of its portfolio guaranteed with moveable property, a category of low importance among the other banks. Perhaps the most interesting finding from this limited amount of information is the negligible presence of accounts receivable as a form of collateral. Along with the emphasis banks seem to place on fixed property ("brick and mortar" in a banker's lingo) as loan security, the irrelevance of accounts receivable as loan collateral unveils a basic contradiction between what manufacturing enterprises are in a position to offer versus what banks are interested in accepting as collateral. On the one hand, the preceding section clearly portrayed the difficulties associated with providing real property collateral in loan contracts. All potential borrowers, and manufacturing firms are no 39 Although technically this is the obligation of the borrower, in actuality lenders and borrowers share this task, as both recognize their interests in expediting the loan. 40 Six banks were requested to respond this questionnaire. A fifth bank did not provide a breakdown of its portfolio by type of security, and the sixth bank has not fulfilled its pledge to send the responses after our departure from Accra.  29 exception, face this constraint and would prefer to pledge a different form of loan collateral. Furthermore, manufacturing enterprises are likely to hold documented accounts receivable such as local purchase orders and contracts which could play a significant role as loan security, were banks open to this type of collateral. The reluctance to engage in lending secured with collateral other than fixed property in general and especially with documented receivables can be explained by the costs and risks banks perceive involved in such operations. Further discussion of alternatives to loans secured with real property is presented later in this section. 3. Constraints on Debt Collection and Enforcement Formal loans. There are few legal restraints on the collection of formal debts; that is, the laws of procedure are based on the British model and appear reasonable. As in most western countries, the formal recovery of loans in Ghana is a cumbersome and expensive process that most lenders prefer to avoid. Most lenders choose to reschedule or reduce repayment terms instead of going to court, as it is less expensive. The inhibiting factors are practical and increase both the cost of collection and the risk of non-payment to bankers. Judgement. The process for debt collection (on any type of property) begins with a formal legal judgement, which could take anywhere between 4 months and 1-3 years. First the lender must decide that the debtor is in default. This is often a subjective judgement on the lender's part, which usually occurs 1-3 months (or longer) after the borrower has failed to service his debt. The first action usually taken by a lender is a letter from a lawyer stating that the debtor is in arrears and that court action will be taken if the debtor does not begin repayment within a month. Often this is enough to elicit a response from the debtor, after which both parties will negotiate a repayment schedule. If, however, the debtor does not respond to this letter, the lender will seek a judgement of default from the court. The debtor receives notice of this hearing and is invited to appear within 8 days, after which time he has 14 days to present defenses. If the claim is uncontested, a judgement for the creditor is entered immediately, at which point he can begin collecting the debt (or foreclosing the mortgage). If the claim is contested, which it usually is, the case goes to trial, which can take 6 months to 2-3 years, depending on the court's backlog. 41 Then, after a favorable ruling by the court, the lender may collect. The most common complaint against the requirement of pre-foreclosure judgement is that judges tend to side with debtors, extending repayment terms and amounts in favor of the debtor. This is explained by the strong tradition of equity in Ghanaian courts. That is, many lawyers and bankers observe a certain sympathy held by judges for debtors, particularly when they are about to lose their property. As a result, judges often rule that the circumstances are such that the debtor should be given an extension of time to repay his debt. Sale of collateral. After winning a judgement from the court, the lender must then sell the collateral in order to realize his cash,42 a process which takes between 5 - 12 months. Before the lender may sell, however, the debtor is entitled to redeem the property within 30 days of judgement. If the debtor has not redeemed the property by then, the property is appraised by a (private) certified appraiser. Due to a shortage of qualified appraisers, this can take 3 months. Then the property is auctioned. The 41 The court's backlog was alleviated late last year (1992) by doubling the number of High Court judges in Accra from 8 to 16. Another reason for this long period is the court's summer recess, which lasts from late July to mid-October. 42 Foreclosure sales are governed by section 18 of the Mortgage Decree of 1972, N.R.D.C. 96.  30 sale of real property can take anywhere from 1 to 6 months (on average), depending upon the type of property, the current market, and the lender's luck. This time period compares well to foreclosure sales in the U.S. Residential property is said to move more quickly than other kinds of property, as it enjoys a wider market of buyers. In contrast, commercial and industrial properties are sold more slowly, especially if they are designed for special use, which limits their marketability. Moveable property is said to take 6-8 months to auction. The strong cultural values associated with real property can sometimes delay or prevent the sale of foreclosed-upon land, especially in the northern rural regions. For example, rural communities (e.g. Kuau) often ban together on behalf of a defaulter and boycott foreclosure auctions, making the property unsalable (in which case it may be less expensive for the bank simply to write off the loan). This clearly creates a disincentive for banks to lend against this type of property; however, the situation does not lend itself to a clear legal or regulatory solution. While the difficulties in foreclosing upon and selling collateral do negatively impact lenders, it is doubtful whether or not it is a decisive factor in decisions to extend loans. Bankers will loan money whenever they feel it will be profitable; thus, if the return on a loan is seen as worth the risk of default, the lender will extend the credit. Of course, reducing the cost of foreclosure will reduce the bank's exposure to losses, which could theoretically lead to less timid lending. However, as long as Treasury bills pay a higher rate of interest than every other sector (as they currently do), neither manufacturing nor commerce will be attractive risks, regardless of the costs of foreclosure. Alternatives to loans secured by real and moveable property. Bankers have legal alternatives to these cumbersome procedures, but these alternatives face practical constraints. For example, it is possible to take security interests in liquid assets, the foreclosure upon which is much quicker than that for real and moveable property. However, many debtors, especially traders, are not in the habit of saving money in liquid accounts; rather they tend to either move it into the informal economy, or reinvest it in their businesses. Another alternative would be for the bank to accept the assignment of contractual benefits (payments) from the borrower. This arrangement is known in Ghana, but not chosen by banks, as they prefer to stay out of others' contracts.43 Reforming foreclosure procedures would be a complex and time consuming procedure and it is doubtful that it alone would stimulate lending to the private sector. Rather, if the driving concern is to facilitate access to credit, measures that make private firms a more attractive credit risk and a more profitable use of bank assets would probably produce better results sooner. The reason foreclosure procedures matter, as all other procedures involved in lending, is their incidence in the banks' transaction costs of granting loans. In this sense, foreclosure procedures have a reduced incidence as compared to other procedures, e.g., evaluation of loan applications, since the former apply only to the proportion of loans in default. If transaction costs of lending are high, the net margins banks expect from loan operations do not compare favorably against the safe investments represented by treasury bonds and short-term speculation in the money market, where banks rotate funds through subsidiaries and back to the parent institution, earning marginal returns at every stage of the cycle while never being transformed into real expenditure. 43 It is important to note here that the majority of contracts for products and services is granted by the government, which is reputed to pay its contracts late. Although the government does indeed pay, in the event it were not to pay, few banks would readily sue the government, as the process is even more protracted than a private suit, requiring the permission of the Attorney General.  31 Reducing bank transaction costs of lending would constitute a step in the right direction, although not removing the main disincentive to lend to the private sector represented by the attractive returns associated with lending to the government. The initiatives some private sector institutions are exploring in the area of information systems, data bases, and credit reporting agencies offer potential economies in information gathering, loan evaluation and risk analysis that banks would certainly benefit from. If the safe haven of the Treasury were to disappear or reduce its significance, financial institutions are likely to generate a strong demand for services that reduce their costs of lending and thus improve their expected profit margins.  32 TABLE 1. TOTAL LOANS OUTSTANDING BY TYPE OF COLLATERAL SELECTED, BANKS, 1992 AMOUNTS IN MILLIONS OF CEDIS; 560 CEDIS = $1 Fixed Moveable Liquid Accounts * Property Property Assets Receivable Guarantee Unsecured Bank 1 16847 421 1404 0 2920 1039 (74.4%) (1.9% ) (6.2%) (13.0%) (4.6%) # of loans n.a.** n.a. n.a. n.a. n.a. n.a. avg. amount n.a. n.a. n.a. n.a. n.a. n.a. ~nk2 701 23 162 56 80 103 (62.3%) (2%) (14.4%) (5%) (7.1 %) (9.2%) #of 23 2 5 3 4 30 loans (34%) (3%) (7.6) (4.6%) (6%) (45%) avg. amount 30.5 11.5 32 18.7 20 3.43 Bank 3 n.a. n.a. n.a. n.a. n.a. n.a. # of loans n.a. n.a. n.a. n.a. n.a. n.a. avg. amount n.a. n.a. n.a. n.a. n.a. n.a. Bank 4 2059 4488 0 0 2897 1446 (18.9%) (41.2%) (26.6%) (13.3%) # of 59 86 0 0 50 44 loans (24.7%) (36.0%) (20.9%) (18.4%) avg. amount 34.9 52.2 57.9 32.9 * Accounts receivable include local purchase orders, contracts, and post::aated checkS. ** "n.a." means not available.  33 TABLE 2. MANUFACTURING LOANS AND OVERDRAFTS BY TYPE OF COLLATERAL SELECTED BANKS, 1992 AMOUNTS IN MILLIONS OF CEDIS; 560 CEDIS = $1 Fixed Moveable Liquid Accounts * Property Property Assets Receivable Guarantee Unsecured Bank) 5849 779 313 0 702 155 (75%) (10%) (4%) (9%) (2%) # of loans n.a.** n.a. n.a. n.a. n.a. n.a. avg. amount n.a. n.a. n.a. n.a. n.a. n.a. Bank 2 205 0 0 0 0 2 (99%) (1 %) # of loans 5 0 0 0 0 2 (71 %) (29%) avg. amount 41 0 0 0 0 1 Bank 3 3388 931 0 0 545 3691 (39.6%) (10.8%) (6.4%) (43.1 %) # of loans 18 3 2 9 (56.2%) (9.3%) 0 0 (6.3%) (28.1 %) avg. amount 67.2 266.7 0 0 272.5 223.3 Bank 4 872 1560 0 0 1635 505 (19.1%) (34.1 %) (35.7%) (11.1%) # of loans 20 31 0 0 n.a. 13 avg. amount 43.6 50.3 n.a. 38.8 ¥ Accounts receivable mclude local purchase orders, contracts, and post=<lated checks. ** "n.a." means not available.  34 TABLE 3. COMMERCIAL LOANS AND OVERDRAFTS BY TYPE OF COLLATERAL SELECTED BANKS, 1992 AMOUNTS IN MILLIONS OF CEDIS; 560 CEDIS = $1 Fixed Moveable Liquid Accounts • Property Property Assets Receivable Guarantee Unsecured Bank 1 6822 182 1092 0 910 91 (75%) (2%) (12%) (10%) (1 %) # of loans n.a.** n.a. n.a. n.a. n.a. n.a. avg. amount n.a. n.a. n.a. n.a. n.a. n.a. Bank 2 238 0 29 15 2 56 (70%) (8.5%) (4.4%) (.6%) (16.5%) #of 8 0 3 1 1 15 loans (29%) (11 %) (4%) (4%) (54%) avg. 29.8 0 9.7 15 2 3.7 amount Bank 3 2760 1222 0 0 0 675 (59.2%) (26.2%) (14.5%) #of 11 4 0 0 0 2 loans (64.7%) (23.5% ) (11.7%) avg. amount 250.9 305.5 0 0 0 337.5 Bank 4 411 630 0 0 218 256 (27.1 %) (41.6%) (14.4%) (16.9%) #of 9 10 0 0 8 6 loans (27.3%) (30.3%) (24.2%) (18.2%) avg. amount 45.7 63.0 27.3 42.7 * Accounts recelvab1e indude local purchase orders, contracts, and post'"datea checks. ** tln.a." means not available.  III. TRADE CREDIT AND ENTERPRISE FINANCE A. Theoretical Framework Trade credit, i.e., financing extended by non-financial firms or individuals linked to the purchase/sale of goods or services, is an area where little research has been carried out in Sub-Saharan Africa. Evidence from developed economies and developing countries in Asia and Latin America, as well as preliminary observations during the RPED panel survey in Ghana, suggest that this source of enterprise finance may entail particular significance. The limited evidence of trade credit activity in Africa appears to be more a result of insufficient research than a real fact. Studies in Chad, Niger, and Zaire have documented significant lending activity among traders in rural areas. Trade-credit in these cases has primarily taken the form of advances towards future crop purchases, but also entails credit unrelated to the commodity transactions. Furthermore, traders were well connected with the formal financial system, in addition to participating in other informal financial transactions. One-half of wholesale traders interviewed in Niger had loans from banks, while one-third had received credit from other merchants and suppliers. Retail traders, on the other hand, relied primarily upon informal credit from merchants and suppliers to finance their operations. A recent survey of small-scale enterprises in suburban Banjul, The Gambia reports extensive use of supplier credit and customer advances to finance current operations. Supplier credit stands out in the case of bakeries, with lesser incidence among tailors and tie-dye producers. Customer advances, Le., the other major form of trade credit, had been received by almost two-thirds of all entrepreneurs in the sample, showing striking incidence among metal workshops, tailors, and tie-dye operations. These data also revealed some incidence of supplier credit as the primary source of initial capital among bakeries and tie-dye workshops. More than three-fourths of the modern bakeries had started with loans granted by foreign suppliers under local bank guarantees. In summary, trade credit may be an essential element in the financing of manufacturing firms. Supplier credit and customer prepayments may account for a significant share of both investment and working capital expenditures. Assessing the true magnitude and scope of trade credit, understanding the nature of trade credit transactions, the determinants of contracting patterns in trade finance, and the constraints binding trade-credit operations is essential to comprehend the functioning of financial markets for the manufacturing sector. The delicate nature of trade-credit transactions explains in part the paucity of empirical evidence on this subject in Sub-Saharan Africa. In addition, the dominance of specific ethnic groups in trading activities in Sub-Saharan Africa, e.g., Lebanese and Mauritanians in The Gambia, Indians in Mozambique, Haussas in Niger, makes documenting trade-credit connections and investigating the nature of trade-credit contracts especially difficult, yet not impossible. Careful design of case studies and keen interviewing of manufacturers and traders should uncover the magnitudes and scope of trade finance in Sub-Saharan Africa. Central issues in the study of trade credit are: (a) at the descriptive level, the relative importance of trade finance among manufacturing enterprises, its relevance across different manufacturing sectors, and its share in firms' debt and asset portfolios; and (b) at the analytical level, understanding the nature  36 and characteristics of trade-finance contracts, the determinants of contracts characteristics, and the choice of contracts by trading parties. As for the trade-credit sector as a potential channel of policy intervention, the central issue is its role as a financial-market integration mechanism, the constraints faced by traders to access formal financial services, and the boundaries to trader contracting. The regulatory environment affecting trade and financial contracts, the incentive structure determined by existing regulations in the financial and commercial markets, are important research subjects in this area. Trade credit and policy interventions It is widely believed by governments and donor agencies that limited access to finance poses a major constraint on the growth of small business. While governments and aid agencies have concentrated their energies on the provision of bank finance, trade credit has all but been neglected in the policy debate. This study seeks to fill the gap by examining whether government or donor agency interventions could enhance the role of trade credit, thereby encouraging the growth of firms and the expansion of employment and output. Before taking policy decisions it is crucial to understand the reasons why trade credit exists in the first place. Various rationales have been suggested for the existence of trade credit - finance market imperfections, the reduction of joint transaction costs, administrative convenience, the limitation of opportunistic behavior by buyers or sellers, the sales promotion motive, and others. Depending on which of these motives is dominant, the resulting policies that could be adopted by the government or donors would be very different. For instance, if the primary objective of trade credit were to constrain opportunistic behavior by sellers, then it is unlikely that the government or donors could engage in welfare-improving policy with respect to trade credit. If, on the other hand, there were inefficiencies in the systems which restricted the use of trade credit, corrective policy could play an important role. Hence the following investigation into the determinants of trade credit use in Ghana has direct bearing on the economic policy of the government and of donor agencies. The investigation is intended to throw light on two policy measures which might be considered by the government and donor agencies: 1 a. Does bank lending and donor-encouraged lending to large and medium-sized business percolate through to small business by means of trade credit? This is an important question to investigate, because the experience of donor-assisted lending programs to small and medium enterprises has been disappointing, with the lion's share of the loans going to larger businesses. If, however, I Related areas which may be considered in the future include: a. Should the government or donor agencies facilitate the development of factoring, which would enable greater flexibility in cash flow management and could lead to the expanded use of trade credit? b. Should the government or donor agencies help create the institutions and legal structures to permit the financing or hypothecation of receivables so that these can act as collateral for lines of credit? See Duggleby et aI. (1992), p. 15; and Appel (1986), p. Sf.  37 increased bank lending to larger firms leads to on-lending to small firms in the form of trade credit, then there is more justification for these programs than has previously been thought. b. Should the government and credit agencies facilitate the establishment of a centralized system of individual credit checking and reporting, or a system of firm credit ratings such as Dun and Bradstreet's Reference BooK!2 Definition or trade credit For an individual firm, trade credit includes four elements: (a) the reception of goods and services from suppliers, on the understanding that payment is to be made later ("accounts payable"); (b) the shipment of goods and services to clients, on the understanding that payment is to be made later ("accounts receivable"); (c) the prepayment to suppliers for goods and services to be received later; and (d) the reception of prepayment from clients for goods and services to be supplied later ("layby" schemes, deposits, etc.) While this definition of trade credit incorporates trade credit received from foreign (Le. overseas) firms which supply machinery and raw materials, the bulk of this monograph concerns local, that is Ghanaian, trade credit. In much of the finance literature, and in published statistics, trade credit is understood to be deferred payment for goods (a and b), and the prepayment side (c and d) is omitted from consideration. This omission may have been justified in developed countries where prepayment plays a small role. In developing countries, however, and in particular in the wood and metal sectors in Ghana, prepayment for goods and services is too frequent to be ignored. The importance or trade credit Trade credit forms a substantial part of short-term financing for most companies in developed and less developed countries. Table 1 shows that in the U.S. in 1983, trade debt was the single largest source of credit for U.S. nonfinancial corporations. Accounts payable amounted to some $428 billion, whereas bank loans outstanding were some $402 billion. By contrast, prepayment was not very common in the U.S. Schnucker's (1992) survey of U.S. firms revealed that only 3% of firms required prepayment "always", while 7% required prepayment "frequently". 2See Johnson and Kallberg (1986), p. 9. It should be noted that a credit checking and reporting system might facilitate not only the expansion of trade credit, but the extension of other forms of credit as well, e.g. bank credit and mortgages.  38 TABLE 1. SHORT-TERM LIABILITIES OF U.S. NONFINANCIAL CORPORATIONS, 1983 Type $ bill. Bank loans 402 Commercial paper 38 Bankers' acceptances 9 Finance company loans 101 Trade debt 428 Profit tax payable 8 Total 985 Source: Bench (1987), p. 21. FIGURE 1. Accounts payable as a percent- age of total assets, U.S. corporations, 1952 (source: Goodell. 1959:52) <=$:50,000 $0. 25m $111 $10lIl $100n1 SO. 01m SO. 511 SSm S50m >S100111 TOT A LAS SET S Fr I.: C:\RPEIl\CASE1\GR3.D:lM Figure 1 demonstrates the well-known fact that small firms are heavier users of trade credit than large. The ratio of accounts payable to company assets falls from about 18% at the smallest firm sizes to only 4% at the largest. While the data pertain to US corporations as of 1952, the pattern may well be similar for other periods and other countries. Given that small firms are highly dependent upon trade credit, it is surprising that so little research has been conducted on trade credit in less developed countries, despite the strong interest of governments and donors in strengthening the small firm sector. Table 2 presents some data on sources and uses of funds by small firms (5-30 employees) in New Zealand in 1966. Accounts payable represented 23 % of all sources of funds, second only to retained profits at 37%. Accounts receivable were the third largest use of funds, after fixed assets and stocks.  39 TABLE 2. SOURCES AND USES OF FUNDS BY SMALLa NEW ZEALAND FIRMS, 1966 Sourcesb % Uses % Retained profits 37 Fixed assets 50 Trade creditors 23 Stocks 19 Mortgages 9 Trade debtors 18 Bank loans 8 Cash in bank 9 Equity capital" 13 Other 5 Other 10 Total 100 Total 100 d Debt-equity ratio 1.00 Source: Johns et al. (1978), Table 7.1, p. 111; in turn from a survey of 198 companies, reported in ANZ Bank Quanerly Survey. a Small = 5 to 30 employees .. b Omitting depreciation allowances and recalculating, for ease of comparison with Table 2. C Including loans from directors - because companies are required to distribute a minimum proportion of net profit, which is often lent back as loans from shareholder/directors. d Taking retained profits to be equity and "Other" to be liabilities. The contrast between small and large firms can also be seen in Table 3, which summarizes the financial situation of U.S. manufacturing firms in 1958 and 1978. Trade credit provided some 17-18% of all funds to small- and medium-sized manufacturing firms, as compared to 7-10% for all manufacturers. During the period 1958 to 1978, the debt-equity ratios3 of small- and medium-sized manufacturing firms in the U.S. were higher than those of the universe of manufacturing firms. The debt-equity ratios rose from 0.80 (small and medium) and 0.51 (all) in 1958 to 1.23 (small and medium) and 0.93 (all) in 1978. One of the factors underlying the larger debt-equity ratios of small- and medium- sized firms was their greater dependence on trade credit Total bank debt as a percentage of liabilities and net worth was 11.6% (small and medium) and 13.4% (all) in 1958, and 11.3% (small and medium) and 17.9% (all) in 1978. Superficially, there would appear to be some substitution between bank credit and accounts payable, with larger firms using more loans and smaller firms using more trade credit, possibly due to limitations on their access to bank finance. What is not clear, however, is whether size is a causal factor after standardizing for product characteristics, industrial sector, liquidity positions, and so on. Dependence upon trade credit by small- and medium-sized firms does not imply that they are net trade creditors. Indeed, the opposite is true of U.S. manufacturing firms, where the sizes of accounts receivable and accounts payable of U.S. firms are compared. For both small- and medium-sized firms, and for the universe of manufacturing firms, accounts receivable were greater than accounts payable during the period 1958 to 1978. While small- and medium-sized firms were more dependent upon credit from suppliers than the universe of manufacturing firms, they were also more likely to grant credit to clients than were larger firms: for instance, in the last quarter of 1978 smaJI- and medium-sized firms 3 Here debt includes accounts payable.  40 TABLE 3. LIABILITIES AND EQUITY OF INCORPORATED U.S. MANUFACTURING FIRMS (AS % OF LIABILITIES AND EQUITY): "SMALL & MEDIUM" AND ALL FIRMS 1958 1978 S & Ma AU S&M All Short-term loansb 5.0 3.4 8.3 3.1 Trade accounts & notes payable 18.3 7.8 17.2 9.5 Current portion of long-term debt: a. Loans from banks 0.5 0.3 1.7 0.4 b. Other 1.0 0.4 1.1 0.7 Other current liabilities" 8.4 8.3 8.9 11.7 Total current liabilities 33.3 20.1 37.2 25.5 Long-term debt (due in more than one year): a. Loans from banks 1.7 1.9 0.1 3.7 b. Other 8.4 10.8 8.4 13.1 Other liabilities 1.1 0.9 1.4 6.1 Total liabilities 44.4 33.6 55.2 48.3 Equity 55.6 66.4 44.8 51.7 Total 100.0 100.0 100.0 100.0 Debt-equity ratio 0.80 0.51 1.23 0.93 Source: Andrews and Eisemann (1984), Table 2, p. 78; in turn from U.S. Federal Trade Commission, Quarterly Report for Manufacturing, Mining and Trade Corporations, various issues. a In 1958: firms with less than $1 million in assets; in 1978: less than $5 million in assets. Note that this category includes only incorporated businesses and excludes unincorporated enterprises, most of which are much smaller. b Loans from banks; commercial paper; and other. c "Other current liabilities" and "income tax accruals". TABLE 4. ACCOUNTS RECEIVABLE AND PAYABLE, U.S. MANUFACTURING FIRMS, AS % OF ASSETS: "SMALL- AND MEDIUM-SIZED"a FIRMS, AND ALL FIRMS 1958 1978 S&Ma All S&M All Receivables 24.7 14.0 28.2 17.1 Payables 18.3 7.8 17.2 9.5 Source: Andrews and Eisemann (1984), p. 82. • See definition in Table 2. were owed an amount equivalent to 28.2% of their assets, the equivalent figure for all firms being  41 17.1 %. Long et al. (1992) find, in their sample of 366 manufacturing firms in 1987, that "days of sales outstanding" (i.e. annual sales divided by 365) were 63, while "days of purchases outstanding" were substantially less, at 49 (see Table 4). Usage of trade credit varies greatly within narrow subsectors. Table 5 presents the ratio of accounts payable to accounts receivable for various subsectors of the U.S. trading sector in 1974. The ratio for the sector as a whole was 0.88, i.e. the trading sector was a net creditor. At the one end of the spectrum was the furniture trade subsector, whose accounts payable were only 0.64 of its accounts receivable. At the other end was the food trade subsector, whose payables were 3.12 times its receivables. Speed of turnover may form part of the puzzle in Table 5. In the food trade, in eating & drinking, and in apparel, receivables are low probably because the retailers offer only cash terms - in turn because the goods have low salvage value (e.g. food is perishable). The furniture trade, however, may grant extended payment terms to businesses and to consumers because the goods are not perishable and have a high salvage value. This may help explain why the food, eating and drinking, and apparel trade sectors all have high ratios of payables to receivables, whereas the ratio is low for furniture and other trade sectors. TABLE S. RATIO OF ACCOUNTS PAYABLE TO ACCOUNTS RECEIVABLE FOR THE U.S. TRADE INDUSTRY, 1974 Industry group Ratio All retail trade 0.88 Business materials, garden sup- plies, mobile homes 0.67 General merchandise stores 0.66 Food stores 3.12 Automotive, service stations 0.70 Apparel and accessory 1.11 Furniture and home furnishings 0.64 Eating and drinking 1.29 Miscellaneous 1.26 Source: Andrews and Eisemann (1984), Table 5, p. 83. Literature review The early literature on trade credit was concerned above all with its effects on monetary policy. Meltzer (1960) and Brechling and Lipsey (1963) claimed to show that when monetary policy is tightened, firms increase their trade credit, both granted and received, by running down their liquid assets such as cash and government securities. Trade credit thus attenuated the effects of monetary policy. On the  42 other hand, Junk (1964) and Nadiri (1969) found that net trade credit was insensitive to changes in monetary policy.4 The more recent literature, by contrast, attempts to provide a microeconomic explanation for the existence of trade credit. The puzzle may be stated as follows. Imagine a world with perfect capital markets, with costless enforcement of contracts, and in which the only "difficulty" faced by producers is that the date of delivery of supplies is uncertain. In this world, as has been shown by Ferris (1981), one would observe only very short-term trade credit arising from a transactions motive. The logic is simple: if both the supplier and the buyer are unaware of the precise date on which the goods will arrive at the buyer's door, then both are forced to hold resources idle~. The buyer must hold money to pay the buyer at the uncertain date, and the supplier (obviously) holds inventories in the form of the goods being transferred. By agreeing on terms for payment, the buyer and the seller reduce thejoint costs of holding resources idle. The buyer receives short-term credit when he or she receives the goods and can arrange for payment later, thereby avoiding the need to keep cash on hand. This argument ignores, however, the possibility that the purchaser might have an overdraft facility which would enable payment at any time without requiring the firm to hold resources idle. Hence Ferris' (1981) argument is likely to apply only where overdrafts are not standard. In any case, as Ferris (1981) notes (p. 260), this transactions motive would lead to only very short trade credit terms, probably less than one month. What we observe is quite different to the predictions of this simple neoclassical model. Several "stylized facts" about trade credit have been observed in many countries: (a) Trade credit terms frequently run to 30, 60 or 120 days, which is inexplicable in the transactions framework, unless other market imperfections are present. (b) Implicit interest rates charged on trade credit by suppliers are typically much higher than interest rates on bank credit. A common formula in the U.S. is 2110, net 30, meaning that the buyer gets a 2 percent discount on payment within ten days, failing which payment must be made in full within 30 days. The implicit interest rate is over 36 percent annualized. (c) The direction of trade credit flows depends upon firm characteristics. For instance, trade credit usually passes from financially stronger, and often larger, suppliers to financially weaker, and often smaller, buyers (Weston and Brigham 1981: 367f). 4 Schnucker's (1992:29) survey of U.S. firms found that 88% of respondents said that they "never" relax their credit terms when banks significantly lowered their interest rates, and another 11 % said that they "occasionally" did so. S In Schwartz' (1974) words, "it costs something to match the time pattern of payment for goods with the time pattern of receipt of goods. Buyers benefit if bills are allowed to accumulate for periodic payment. Furthermore, trade credit gives buyers time to plan for the payment of unexpected purchases, enables them to forecast future cash outlays with greater certainty, and simplifies their cash management. " (p. 643)  43 (d) Trade credit terms vary by industry and product type. Risky products carry deep cash discounts; perishable goods and goods with high sales turnover have short terms in the US; the manufacturing sector grants trade credit to the nonmanufacturing sectors more than the other way round. There are several broad sets of explanations for the above stylized facts. These are treated in turn. The financial motive for trade credit The older and more standard view is that trade credit arises from financial market imperfections. Firms with easier access to capital markets pass trade credit to firms with no access to credit or which would be able to obtain credit only on extremely unfavorable terms (Schwarz 1974:644). The firm granting trade credit acts as a financial intermediary, intervening in the market on account of the large spread of borrowing rates. "The institutional arrangement of delayed payment enables established firms to help finance the growth of their younger customers" (Schwarz 1974:655). An alternative explanation is that barriers to banking entry result in banks' receiving noncompetitive rents, which nonfinancial firms may seek to compete away by offering trade credit (Emery 1984). Plausible though the financial motive is, the available evidence is mixed. Some anecdotal evidence in its favor appears in Table 3, which suggests, as has been noted above, some substitution between bank loans and trade credit - with large firms relying more on the former and small firms relying more on the latter, which in turn may be due to the limited access which small firms have to bank credit. Another anecdotal item of evidence in favor of the financial theory of trade credit is the behavior of U.S. car manufacturers at the beginning of this century, who on account of their illiquidity used to sell to dealers on a cash basis (Johnson and Kallberg, 1986:6). Long et al. (1992) regress [receivables/sales] on several variables including [short term borrowings/sales] and find a significant positive coefficient on the latter. This may constitute evidence for the financial or liquidity theory of trade credit. Firms with easy access to loans will in turn use those moneys to sell their goods by means of trade credit. 6 Regrettably the econometrics are defective because variables on the right and the left side of the equation are divided by the same variable (sales), which can result in substantial biases in favor of positive coefficients on the relevant right-hand-side variables. Schnucker's (1992) survey of U.S. firms provides some evidence against the financial theory. The respondents were asked whether they agreed with the statement "The use of trade credit suggests to us that the customer cannot obtain financing elsewhere". 50% said this was "never" true, and 40% said it was "occasionally" true. Furthermore, Schnucker's probit estimates indicated that more liquid firms were no more likely to offer net terms (deferred payment) than were less liquid firms. Information, moral hazard and specialization The financial motive cannot explain the existence of trade credit on its own; some kind of institutional theory must back it up. The question is why the trading firm engages in a dual transaction Note that the authors' interpretation of the coefficient is the opposite. They reason that a firm with high II borrowings is not liquid ex ante and therefore, according to the liquidity theory, should be less likely to offer trade credit.  44 of goods/services and finance at the same time; if the trading firm is able to intermediate, why do other entrepreneurs - informal sector lenders or banks - not enter the market? In short, why do we observe linked transactions? Hence the institutional explanations stress the reduction in transactions costs that trade credit provides. The supplier may know the buyer's financial situation on account of specialized knowledge through industry contacts (e.g. reputation) or through the negotiation process Jeading up to the sale. The seller's clients are a relatively homogeneous group compared to a bank's credit customers. Specialization in credit analysis should produce better and cheaper information about default risk (Emery 1984:279). The third-party financial intermediary would find it more expensive to obtain information on moral hazard (viz. the chance that the buyer will receive the goods and then, genuinely or opportunistically, declare the firm incapable of paying). Furthermore, it may be cheaper for the seller than for a third party to collect bad debts. A trade credit lender may be able to repossess the product, rework and sell it. Emery (1984:279) comments, A bank does not have these repair or distribution facilities and may have to If dispose of repossessed assets at distress sale prices". Hence one will observe tying of goods transactions and financial transactions. The question may then be asked: why, despite the superior information that the trade credit supplier has, is the implicit interest rate involved in trade credit often much higher than the interest rate offered by banks? The answer may lie in the fact that firms which are forced to use trade credit to make purchases are credit-constrained. Either they may not be able to provide banks with security in the form of real estate, or may have exhausted their formal banking opportunities. Then their effective cost of finance from a third party would be very high, and in the extreme, infinitely high. Compared to these unobserved rates of interest, the interest rates implicitly involved in trade credit are lower.  45 FIGURE 2. Accounts payable and bank credit, U.S. firms, as a % of total assets, 1955. (Goodell 1959:86). 40 Frozen 1'oods * 30 r- 20 r- Wines tvlen's shirts ill( Alrcrart part.s lIE Furs ill( Clothing (4) Screens lIE ill( "10 r- lIE Dairy ,. o o 5 10 15 20 2S ACCOUNTS PAYABLE I TOTAL ASSETS (96) FI Ie: c:\rped\case1\gr4,cgrn Trade credit as sales promotion In order to promote sales, suppliers are often willing to provide credit for a purchase in order to complete the sale. Thus they are willing to provide credit until the buyer is able to convert the inventory into cash. They are not willing to finance a buyer's entire inventory, since this would not increase their sales. Accordingly, trade credit terms are often related to the rates of stock turnover (Johnson and Kallberg, 1986:6). Meat and dairy products have rapid turnover rates, so credit terms offered by wholesalers are usually short, typically a week to ten days. Jewellery has a slow rate of turnover, so credit terms offered to retailers may be as long as six months. The corollary of this argument is that firms with rapid turnover are likely to have a larger proportion of their inventories on credit than are firms with slow turnover. Meat retailers might have 90% of their inventory on credit, whereas manufacturers whose raw materials are in process for extended periods will enjoy proportionally less credit. Some evidence in favor of the turnover theory appears in Figure 2, which contrasts the use of accounts payable and the use of bank credit in eighty industrial subsectors in the U.S. in 1955. The sectors with the largest ratio of accounts payable to total assets are, with a few exceptions, in the clothing business. Dairy producers and frozen food producers also make heavy use of deferred payment for intermediate materials. One explanation may be that clothing, frozen food and dairy firms have rapid turnover. (Another possibility is that risk is higher in these sectors than elsewhere - see below).  46 Another sales promotion theory is that of Long et al. (1992), who argue that small firms have difficulty establishing a reputation for the high quality of their goods. There is more publicly available information about product quality for large firms than for smaller ones. In order to compensate and establish a high-quality reputation, small firms will therefore offer trade credit. Long et al. (1992) regress [receivables/salesJ on firm size (proxied by assets or sales) and other variables7 and find a significant negative coefficient on size. They conclude that the reputational motive is strong. Trade credit as screening Smith (1987) suggests that trade credit is a screening contract which elicits information about buyer default risk, taking into account the adverse selection involved in the buyer's decision to pay cash or to opt for terms. Trade credit usually carries high interest rates which only high-return, high-risk buyers will take on. Low-return, low-risk buyers would prefer to pay cash. Thus the decision by the buyer to pay after 30 or 60 days is a signal to the seller to monitor the buyer. The seller is I ikely to offer trade credit terms after making nonsalvageable investments in the buyer, which might include: hiring salespersons to develop specific knowledge of a buyer's operations; entertainment expenditures; or buyer- specific equipment, literature, manuals, etc. Smith's signaling theory provides reasons why trade credit terms should vary depending on product characteristics. An example of trade credit as screening is the following. In risky industries, trade credit terms include deep cash discounts. In women's clothing, for instance, payment terms may be 8/10 net 30, i.e. the buyer gets a discount of 8% for paying in the first ten days, or must pay the full price within 30 days. The implicit interest rate is an annualized 329% (compounding daily). In men's clothing, which is less risky, terms may be net 30, i.e. the financing cost is zero for 30 days. Smith's theory of screening suggests that the women's clothing retailing industry attracts high-return, high-risk entrepreneurs who are likely to seek credit even if it is expensive. The seller in turn will be willing to provide credit, on extremely unfavorable terms, in order to obtain valuable information on buyer default risk. The market then creates an eqUilibrium set of trade credit terms varying with the riskiness of the buyer class - and we observe deep cash discounts for women's but not for men's clothing. Transaction-cost economics, interlocking contracts and the timing of payment flows In the financial literature on trade credit in developed countries, the issue of prepayment is ignored, possibly because it is empirically negligible, and so the main issue of interest is the unidirectional one: under what circumstances will a supplier advance credit to a buyer, and under what terms? In the small-firm sector in developing countries, however, prepayment is common. Under what circumstances will a supplier require prepayment of all or a part of the price of the goods, and under what circumstances will he/she be satisfied with cash upon delivery? The industrial organization literature can throw light on this question. Williamson (1988, 1991) argues that agents rationally choose among governance systems by striving to minimize overall governance costs. He contrasts two governance arrangements: market relations and internal organization. The problem is frequently posed in this way: under what circumstances will a manufacturer buy inputs on the market (or sell output to distributors), and under what circumstances will the manufacturer 7 Brand name dummy, turnover, uniqueness dummy, [accounts payable/sales], short term borrowings, the firm's credit rating, and a measure of the variability of demand for the firm's products.  47 integrate backwards and make the inputs (or integrate forwards into distribution)? Williamson argues that the crucial determinant in the choice of governance arrangements is the degree of asset specificity or idiosyncratic investment involved in the relationship. Asset specificity is "the degree to which an asset can be redeployed to alternative uses and by alternative users without sacrifice of productive value" (1991:281). One example of asset specificity is site specificity. Joskow (1985) hypothesized that mine-mouth coal burning electric plants had considerable site specificity on account of being located next to coal mines. Indeed he found that mine- mouth coal burning plants were more likely to integrate backwards into mining than would other coal burning electric utilities. Where they did not integrate backwards, the plants had unusually detailed, long- . term (35-year) contracts with the mines. 8 The concept of asset specificity has direct bearing on the provision of trade credit. Suppose we are dealing with a specialized product which requires some commitment of resources and some time to complete prior to the sale. Suppose further that the buyer and supplier are not parties to a long-term relationship. Then prepayment in full would impose all the risk on the buyer. It could give the supplier an incentive to supply goods and services of inferior quality or to supply them at a date later than that agreed upon. It is unlikely to be used with highly specific goods. Payment in full upon delivery. on the other hand, imposes all the risk on the seller. 9 The supplier risks last-minute reneging by the buyer, which would force the supplier to absorb the round-trip shipping costs or fmd another buyer in the same area. It may entail a 100% loss if the good is so specialized as to be unsaleable. There has been little testing of the relation between trade credit and asset specificity. In his survey of U.S. firms, Schnucker (1992) asked respondents to indicate whether they agreed with the statement "The quality of our product line is difficult to determine by inspection only". He used the resultant dummy variable in a probit of the decision to offer net terms (as opposed to cash terms only), anticipating that agreement with the statement would increase the probability of offering net terms. The coefficient on the dummy was statistically insignificant. It is possible, however, that the reason for this discouraging result is that Schnucker's data were at too high a level of aggregation, since he had only firm-level data. Transaction-level data might be more revealing. Long et al. (1992) regressed [receivables/sales] on several variables including asset turnover, defined as sales per dollar of assets. The authors intended their asset turnover figure to proxy for production lead times, which in turn ought to be associated with trade credit because higber quality products are involved and these require longer periods of quality assessment by the client. Thus if turnover is slow (Le. sales/assets is low), more trade credit will be offered. In fact the coefficient on turnover is negative and significant, suggesting that asset specificity (proxied by sales/assets) is associated with deferred payment. The result must be interpreted with caution because it could have been contaminated by "Stigler's error". Sales is the denominator in the dependent variable and is the numerator in the independent variable. Given errors in variables, the coefficient is downwardly biased. 8 For an example of asset specificity inducing backward integration in the chemicals industry, see Lieberman (1991). 9 We are assuming that the buyer can quickly and costlessly inspect the good upon delivery, and has the right to return it if the quality is not up to standard.  48 Errors in variables are produced in this case by year-to-year variation in sales. Any particular year's realization of sales is an imperfect measure of the preferred variable, long-term "permanent sales". B. Trade Credit and Enterprise Finance: The Facts 1. The Food Sector The sample interviewed in the case study in January 1993 consisted of nine manufacturing firms in the food and beverages industry. as well as four of their suppliers and three of their clients. Of the nine manufacturing firms, five were small (with ten or fewer employees), one was of medium size (eleven to 50 employees), and three were large (over 50 employees). Annual sales of the nine food manufacturing firms ranged from C3.1m to C319m. The manufacturers produced canned and bottled juices, other beverages, ice lollies, poultry feed, smoked fish, and bread. The suppliers included a cocoa manufacturer, a pineapple farm, a government- owned commodity trade firm, and a maize merchant. The clients included a ice-cream retailer, an ice lolly retailer, and a wholesaler of minerals. Uses and sources of funds of the nine food manufacturers As far as uses of funds are concerned, only one of the nine firms (a large one) had made prepayments to other firms for which the goods had not yet been delivered. It seems a reasonable guess that in the food sector, inputs are completely general in character (e.g. flour, pineapples, fish, cocoa). These inputs are, moreover, highly divisible. There appears to be neither a custom-building element nor any moral hazard involved in these purchasing contracts. As a consequence there is no necessity for prepayment. Five of the nine manufacturers had outstanding accounts receivable. Only one of the nine manufacturers had given loans. As would be expected, this was the owner of one of the small firms, which had given loans to friends. Three loans had been granted and were still outstanding at the time of the interview. The loans had no prearranged maturity; one of them had run for three months. As far as sources of funds are concerned, the three large manufacturers had bank loans and/or overdrafts, while the six small and medium-sized firms had neither loans nor overdrafts. Two of the small firms, in the event both bakers, had obtained informal loans, both from close relatives. In the case of one of them, there was no fixed maturity, interest or final payment; the loan appeared to entail a grant element as it seemed doubtful that some of it would be repaid. Six of the nine firms had outstanding accounts payable. All of the three large food manufacturers were buying on credit. Only two of the nine manufacturers had received prepayments from clients. As was the case with prepayments made, it appears that the products involved do not entail asset specificity and so there is less incentive to require prepayments. Trade credit practices  49 Several respondents in the food sector mentioned that they felt compelled to give trade credit as a means of competing with other firms. A maize merchant insisted that the market was highly competitive and so he was forced to give trade credit; and a maker of smoked fish stated that credit was necessary in order to get the fish moving after a good catch. It appeared that most of the markets in which the respondents operated were strongl y competitive. Most of the manufacturers obtained their raw materials from several different suppliers, or could have done so had they chosen to. Especially in the case of purchases of maize, fruit, and flour, it did not appear that any supplier was in a position to exercise market power. Smaller manufacturers had shorter credit terms than larger manufacturers. The bakers in the sample were small firms and had short terms (two to four days), while the beverage manufacturers were large firms and had terms of up to 30 days with local suppJiers. The short terms obtained by the bakers, however, may have merely been due to their short product-cum-inventory cycle, which induced their suppliers to finance them only until such time as their raw materials had been converted into cash. Various means were used to check the credit-worthiness of clients. Some respondents (notably a baker and a canner of fruit juices) mentioned that they required potential trade credit recipients to buy from them for a long period on a cash basis first. After the client had demonstrated hislher reliability, credit would be granted. Frequently the rule was applied that trade credit was granted only when the client had paid in fuJI for the previous shipment of goods. Other ways of establishing the credit- worthiness of clients included checking with relatives of the client, and acquiring information about the client's business by visiting it. One beverage company required its clients, most of whom were retailers, to pay a deposit, whereupon they would be given consignments up to a maximum value of the deposit. In most cases, food sector firms which granted trade credit had long-standing relationships with their clients. Relationships of twenty years and more were not unconimon. But even in cases where the relationship was long and the client firm was a large and reliable one, the credit term did not extend beyond a month lO • For instance, a cocoa manufacturer sold on credit to an ice lolly manufacturer with over 50 employees with which it had had a commercial relationship for eight years. The outstanding balance had to be cleared within the month. The financial motive for trade credit was probably unimportant in this particular case, because the firms were both large and had ready access to bank finance. The trade credit period was not linked to the production cycle, which extended over approximately two days. The probable reason for using trade credit was administrative convenience. Accounting managers would find it simplest to collect all bills and clear their accounts on a monthly basis. In some cases, the decision to grant trade credit was made after only a short period of cash purchases. For example, a beverage wholesaler sold on cash to a retailer for six weeks, and then decided to grant credit of up to a week at a time. The wholesaler had not known the retailer before the business relationship commenced, but asked his friends who worked for a bank whether the retailer was credit- 10Purchases from firms overseas sometimes carried credit terms of 90 days. These are omitted from consideration here.  50 worthy, and also ascertained her place of residence. He did not, however, know the retailer's level of debt or how many employees she had ll • For most firms, the probability of granting trade credit increased with the size and age of the client firm. Some firms, however, reasoned differently. For example, a beverage wholesaler said that he granted credit to clients (viz. beverage retailers) if they were starting up a business, but not to retailers that were already established. Not all firms granted trade credit. An ice lolly manufacturer with over 50 employees commented that the firm used to grant credit three years previously, in order to get their product known, but that the granting of credit "was no longer necessary" and had been discontinued. A similar view was expressed by a bottler of fruit juices, who was still at the stage of offering credit as an incentive, but who intended to move to cash sales in time to come. 2. Textiles and Garments Given the number of stages in the manufacture of textiles and garments, the coverage of financial transacting by enterprises in this sector in the January survey is relatively sparse. Two firms interviewed were ginning cotton and two were manufacturing yarn; however it was the same two firms in both cases. One of the two is a large, integrated state-owned enterprise which also makes grey cloth as well as finished textiles. With the exception of another large firm manufacturing synthetics, all the other nine firms in the sample were making garments. 1Z Further, only two traders, one wholesaler and another retailer, were covered by the survey, providing an incomplete picture of distribution mechanisms in the sector. The two firms ginning cotton purchase 75-80% of their input on credit, primarily because both firms effectively produce their own cotton: the government-owned firm owns a majority stake in another state enterprise producing cotton, while the private firm is a subsidiary of another major cotton producer in Ghana. There are five producers of cotton, which until recently was mostly imported, but three of these firms are dominant and the survey included two of them. Both producers of cotton have substantive access to bank finance in terms of overdrafts as well as long-term loans. In both cases the sales also are almost entirely on credit since the clients are part of the same holding company. At the next stage, the ginned cotton too is sold on credit to related companies that manufacture yarn; the private firm sells to other manufacturers of yarn also. Finally, the state enterprise extends significant supplier credit, with 65% of its final products (including yarn) being sold on 2 week credit to individual wholesalers and 4-6 week credit to merchandising companies. The single producer of synthetics in the sample also has access to formal credit; it imports all raw materials (Le., cash purchases) and provides limited supplier credit to some known clients that sell wholesale. All three firms neither purchase nor sell against advance payments. IIIn fact, taking all four sectors together, it was only rarely the case that the firm granting credit ever knew the level of debt of the client. 12Two other firms interviewed are not included in the discussion below: one had stopped production and was only selling items in stock, while the other was a sales agent for a foreign government.  51 None of the remaining firms in the sample are representative of the customers of the spinning mills, which are primarily wholesalers and manufacturers of domestic textiles. While the responses of all three large manufacturers indicated extension of supplier credit to individual wholesalers, the sole wholesaler interviewed was not granted credit by any of the five domestic manufacturers of domestic textiles. This was despite the fact that the wholesaler had been transacting with the same firm for five years and had also been granted formal credit in form of bank overdraft. Relative to the other sectors, merchandising companies and departmental stores possibly playa far greater role in distributionoftextiles and garments than small, proprietary wholesalers, and may account for most of sales on credit by the manufacturers. I:! In the absence of further information, however, not much can be said about the distribution mechanism and the role of trade credit in the more downstream units of the sector. TABLE 6. USE OF TRADE CREDIT BY GARMENT MAKERS Firm No. Purchases on Purchases Purchases on Purchases Net Trade credit, pet. with advance credit, pet. with advance Credit payment, pct. payment, pct. Position 1 0 0 60 0 Grantor 2 80 0 0 10 Recipient 3 100 0 100 0 Grantor 4 80 0 0 100 Recipient 5 0 0 0 15 Grantor a 6 0 0 15 35 Recipient 7 15 0 10 50 Grantor 8 40 0 0 0 Recipient 9 67 0 0 0 Grantor .. Source: RPED Case Sudies, Ghana 1993. aThese firms appear as net grantors due to inventories of finished customized products not picked up by the customers. The nine garment makers interviewed typically have the customers bringing in the materials for the garments. 14 Consequently, their purchases are confined to items such as threads, buttons, stiffening for collars, etc.. These are items of low specificity and are easily available in the markets, explaining the complete absence of purchases against advance payments by these firms in the table above. Further, since the customers provide the materials for the garments, there is correspondingly less need for advance payments from customers, both from the point of view of financing working capital and of moral hazard, or repudiation on part of consumer. This is also evident in the table, showing lower reliance on advance payments by customers than in other sectors, such as furniture workshops. However, as in the case of other sectors, there is significant reliance on supplier credit by these firms, many of whom buy from retailers in the market. Finally, the net credit status of the these firms seems ambiguous: a surprisingly I~is applies to domestically manufactured items, not the smuggled new and "foss" clothing. 14These firms include one large, three medium and five small firms.  52 large number of firms appear in the table as net grantors of trade credit. Part of this may be due to the fact that, for at least two small firms, their accounts receivable include garments that were not picked by customers (for many months) at the time of the interview. At the same time, however, the average duration of supplier credit obtained by small and medium firms in the sample is less than the average duration of credit sales. . 3. Wood Products This section looks at the financing activities of firms in the wood and wood processing sector using data obtained from the January survey. In addition to six traders in the lumber market in Accra, 12 firms were interviewed, nine of which were also part of the larger survey conducted earlier while the rest were suppliers of at least one of these firms. In terms of size, the January sample included four large, six medium and two small firms; all the trading firms were small. A useful way to view enterprise finance in the sector is to view the behavior of firms at different points in the product chain. Consequently, the firms in the sample have been divided into two groups. The first contains the lumber companies that buy logs from logging firms (none of which were part of the sample) and either sell them directly or after some processing: two such firms were interviewed in detail during January. In the second group are the firms that purchase the wood and make furniture for household or business use. In addition, as noted, six firms in the sample were trader wholesalers or retailers, intermediating primarily between the smaller furniture-making firms and the larger lumber companies. Kumasi forms the major center for the first stage in the wood processing sector: trees felled in the surrounding region are brought to Kumasi where they are sawed and processed by mostly large lumber companies. This is a fairly well-organized market with most firms belonging to a Timber-Millers' Association, or a Loggers' Associations for loggers. Consequently, the firms seem to know other participants in the market, among both the milling companies and the loggers, and the established ones can thus make flexible arrangements for supplies and payments; disputes can be arbitrated, if necessary, by the associations. Although neither of the two firms interviewed in Kumasi owns any forest land where logging is done, they are both well established firms with close connections to the logging companies that are their primary suppJiers. One of these firms had been in business since 1962 and had been trading with its primary supplier for 20 years, while the other had started in 1984. The credit relationship with suppliers for both firms took the form of rolling accounts whereby settlements are made periodically, inevitably spanning more than one transaction, and the net balance may be negative or positive at any point in time without affecting the flow of real (goods) transactions. 1S Both milling firms in Kumasi had access to considerable supplier credit, one buying half and the other all its inputs on credit. At the same time, their sales are mostly on cash basis, being all exports : only inferior quality wood and defective output rejected from exports are sold for domestic consumption. The supplier credit is relatively short term and repayment seem to depend upon shipments made by the firms for exports. However, both firms also had access to large overdrafts from banks (in 15Another manifestation of the close relationship between the milling firms and the loggers is found in data from the larger survey which showed a total of four informal loans by large firms to suppliers, all of which were in the wood processing sector.  53 excess of 100 m cedis) and could also get pre-shipment finance from them (equaling up to 80% of the value) against letters of credit for exports. Given this substantial access to credit, one would expect them to provide credit to other firms that may not be as liquid, but both firms appeared to be net receivers of trade credit. This may be an artifact attributable to the combination of the firms' exporting the bulk of their output, implying cash sales, along with purchases on credit. In their domestic sales, however, such large companies may be net grantors of credit. 16 Discussions with traders in the lumber market in Accra tended to support the notion that upstream milling companies provide supplier credit in their domestic sales. 17 A total of six retailers and wholesalers were interviewed in the lumber market in Accra. However, one of the firms classified as a supplier is also in actuality a trading enterprise in the same market and is, consequently, treated as the seventh firm interviewed in this category. The lumber market in Accra is the primary source of wood for furniture makers, building contractors, and other types of firms associated with carpentry. The traders may purchase logs or processed wood either directly from manufacturers and arrange for transportation, as two of the traders interviewed did, or purchase from suppliers delivering truck "lots" to the Accra market. The trading firms interviewed display considerable diversity: for example, degree of integration in their activities ranged from one firm, started in 1992, that was confined to buying lots at the market and retailing them to small buyers, to another established firm that, in addition to its wholesaling activities, also owned a logging concession, owned and operated sawing machines in the market to process its own logs and those bought by other shops, and had a construction business in Accra utilizing many of its wood products. Similarly, while the youngest firm was barely a year old, the oldest one had been in business since 1968. Although the sample of traders is not large, their transactions seem to indicate that the lumber market is an important conduit for the flow of credit in the wood processing sector. The table below shows the use of trade credit by the seven retailers and wholesalers in the market. Since there were no sales or purchases on consignment basis, the residual purchases or sales in the table are the percent of total purchases/sales that are cash transactions (not shown). It is evident from the table that a significant proportion of the purchases of these firms are in the form of supplier credit: four traders purchase their wood on credit, in proportions varying from a third to all the input purchases. Both firms that do not use supplier credit have been in the market for at least 10 years, suggesting that they could perhaps arrange access to credit if desired. ls This is supported by the fact that one of the two acquired all its inputs through lending to the suppliers in the form of advance payments, and in addition also has 30% of its sales to client on credit basis. Similarly, another firm that appears to get minimal supplier credit also purchases mostly on advance payment and lends to customers as well. Given low specificity of these products and insignificant incidence of cash discounts, the use of advance payment may be attributed to attempts at ensuring quality and timely delivery of goods, especially when demand for them may be high. 160ne of the firms reported that at least 40% of the logs may be unsuitable for exports and thus either go waste or are sold domestically. 17Note, however, that there may be independent companies in between the milling companies and wholesale markets that are sources of trade credit; none such firms were encountered in the January survey. ISOnly one trading firm had access to bank overdraft (first one in the table).  54 TABLE 7. USE OF TRADE CREDIT IN THE LUMBER MARKET, ACCRA Trader No. Purchases on Purchases Purchases on Purchases Net Trade credit, pet. with advance credit, pet. with advance Credit payment, pet. payment, pet. Position 1 33 0 0 0 Grantor 2 0 100 30 5 Grantor 3 60 40 45 0 4 50 0 0 0 Grantor 5 100 0 ~ 6 0 0 Ci 5 7 5 95 30 0 Grantor a Source: RPED Case Sudies, Ghana 1993. a Percentage not known but sells to "many" clients. b Used to sell on credit, but not anymore due to repayment problems. It is also evident from the table that credit can flow in both directions between traders and suppliers of logs or wood, since some of the traders also buy on advance payment basis. For example, although all four trading firms for whom figures are available are net grantors of trade credit, advance payment to suppliers (rather than credit sales to customers) seems important determinants for this in two cases. Indeed, a comparison of the first two columns (purchases by traders) with the last two indicates a significantly higher scope of trade credit in the purchases of traders relative to their sales. The greater visibility of trade arrangements in case of purchases may be due to higher "credit ratings" of the parties involved: large and medium companies supplying goods to traders with fixed sites, often established in terms of trading volume and age. In contrast, customers of the trading firms are far more and diverse although usually small. The other component oftrade credit, sales on advance-payment basis is virtually absent in sales of the traders. This is probably because of low product specificity and the fact that the large number of trading firms in the market generally ensures spot presence of wood sought by any client, rendering unlikely the need for future order or advance payment to ensure reliable delivery. Further, to the extent trading firms are more liquid than the furniture workshops, it would again be expected that credit would flow from traders and advance payments from customers would be low. The last group of firms in the sector are the diverse furniture workshops that process the wood for use by individuals or firms. Of the nine such firms in the January survey, only two had access to bank overdrafts. As can be seen in the table below, however, most of these firms could purchase raw materials on supplier credit, ranging from 30 to 80% of their total purchases. As noted in the section on trade credit, customized orders with high degree of specificity tend to be associated with advance payments - a common occurrence in the wood processing sector; virtually all firms in the table rely to varying degrees on advance payments from clients. At the same time, relatively few of their purchases are on advance-payment basis. This is consistent with the minimal sales against advance payment in the previous table. Finally, as might be expected, this group of firms has a high incidence of net recipients of trade credit: net recipients outnumber net creditors by a factor of two.  55 In sum, the transactions of firms in wood and wood processing sector can be seen to be financed by three types of sources: formal bank overdrafts, traders' funds, and final customers of the sector; these funds are intermediated most frequently in the form of trade credit. The sawing and milling firms purchasing logs are typically large, with access to overdrafts and pre-shipment finance for exports as well as some credit from domestic sales to trading firms on advance-payment basis. They also have flexible arrangements with suppliers of logs, enabling further access to (supplier) credit, with repayments geared to receipts of revenue. The firms upstream appear to provide supplier credit for goods not exported but sold in domestic market; this credit is intermediated further by the trading firms to the workshops. At each stage in the process, credit contracts are characterized by flexible repayment schedules closely linked to revenue receipts for the debtor firms. 19 The furniture workshops, as a group, comprise the smallest firms in the sector, with the least access to formal finance, and rely exclusively on advances from customers and, where feasible, supplier credit from retailers and wholesalers. TABLE 8. USE OF TRADE CREDIT BY FURNITURE WORKSHOPS Firm No. Purchases on Purchases Purchases on Purchases Net Trade credit, pet. with advance credit, pet. with advance Credit payment, pct. payment, pet. Position 1 80 20 0 10 Recipient 2 20 40 0 95 Recipient 3 30 0 0 45 Recipient 4 0 20 0 0 Grantor 5 25 5 38 37 Recipient 6 0 0 0 100 Recipient 7 0 0 20 10 Grantor 8 50 0 0 100 Recipient 9 70 0 30 70 Grantor Source: RPED Case Sudies, Ghana 1993. 4. The Metal Sector The sample interviewed in the metal sector consisted of nine firms, as well as two of their suppliers and one of their clients, a large department store. Of the nine metal manufacturers, three were small firms (with ten or fewer employees), four were of medium size (between 11 and 50 employees), and two were large (with over 50 employees). Annual sales of the nine metal manufacturers ranged from C6.7m to C1233m. 19Contractual attributes of trade credit contracts, criteria for providing credit, etc., do not appear to vary across sectors. They are excluded from discussion here since they are covered in another part of the report.  56 The manufacturers produced aluminium utensils, window frames, gates, stoves, ovens, coal pots, slide gigs, gas ovens, hospital beds and other hospital equipment, while one engaged in metal repair services. Their most important raw materials were metal sheets, ball bearings, steel tubular pipes, angle irons, iron scrap (e.g. condemned trucks, small metal items), iron plates, valves (imported from overseas), aluminium sheets, and aluminium disks. The suppliers that were interviewed sold steel sheets and aluminium disks. Uses and sources of funds of the nine metal manufacturers Only two of the nine ftrms had any prepayments outstanding. Both of these ftrms were large (over 50 employees). The supplying ftrm, the managing director of which was also interviewed, was a monopolist, possibly because of the economies of scale involved in manufacturing aluminium sheeting and disks. It appeared that the supplier, being a monopolist, was in a position to require its clients to pay in advance for all sales. In the case of the seven remaining ftrms, the chief raw materials purchased were entirely lacking in asset speciftcity, possessing read iIy deftnable characteristics desired by a large contingent of clients. The absence of prepayments can probably be ascribed to the generality of the products involved. Seven of the nine metal manufacturing ftrms had outstanding accounts receivable. One of the small ftrms had no accounts receivable because it had - officially - stopped granting credit some eighteen months before, as a result of being cheated; yet the owner admitted that some 20% of his sales were effectively made on credit because people delayed making payment (this was sometimes referred to as "forced credit"). One of the medium-sized ftrms had no accounts receivable because it was devoting itself solely to a single large government contract to supply stoves, for which a 50% payment had been made in advance. Only one of the metal manufacturers, in the event a small ftrm, had loans to friends outstanding. The owner had made a loan to a friend for use in his business, and did not know when it would be repaid. As far as sources of funds are concerned, the two large ftrms (i.e. those with more than 50 workers) had overdraft facilities and at least one of the medium-sized ftrms had a substantial bank 10an20. None of the four small metal manufacturers had access to bank ftnance. Only two of the nine manufacturers (one small and one medium had loans from friends. Unlike the situation in the food sector, purchases on credit were not common in the metal manufacturing sector. Only two of the nine metal manufacturers reported positive accounts payable at the time of the interviews (January 1993). In addition to these, one ftrm bought on credit regularly and another occasionally, but happened to have no outstanding accounts payable at the time. Three factors explain why accounts payable were not an important source of working capital for this (admittedly small) sample. First, the two largest ftrms were both clients of a monopolist who required them to pay in advance. Second, two of the respondents bought on a cash basis in the market or at scrap metal yards or at auctions. Third, one of the ftrms (#5) imported most of its raw metal by means of a Letter of 20One other medium-sized ftrm may also have had access to bank finance, but its ftnancial situation is not known with precision.  57 Credit which in effect amounted to cash purchases; this owner commented that it would have been possible to obtain credit from these overseas suppliers, but the charge of 17.5 % for 90 days was too high. Finally, prepayments were an important source of working capital for the metal manufacturers. Six of the respondents reported that they were in possession of prepayments from clients for which they had not yet supplied the goods. All three of the small metal firms had received such prepayments. It appears that moral hazard and asset specificity are among the causes of this profusion of prepayment. The products made by the manufacturers were somewhat lumpy and in some cases adapted to the particular needs of the client. If the client were to repudiate the arrangement after completion of the job, the manufacturer would at best be left with an inventory item which could take a long time to move and would therefore be faced with cash flow difficulties; at worst he/she would suffer a substantial loss when trying to sell an unwanted product. In a few cases - and these are dealt with in the hypothesis testing section of this paper - the reason for desiring prepayment could not be traced to moral hazard or asset specificity; it appeared to be driven purely by the liquidity needs of the manufacturer. To summarize: trade credit (accounts receivable) was the most important use of funds in the metal manufacturing sector, and prepayments were the most common (not necessarily the largest) source of funds. Unsurprisingly, bank finance was the largest source of funds for large metal manufacturers. Trade credit practices One large metal manufacturer required its clients (all traders) to pay a substantial deposit in order to become a client. Then the manufacturer supplied goods to these retailers on very short term credit, typically fewer than seven days, to a maximum value of the deposit made. This approach had two purposes: to act as a guarantee should the retailer default, and to exclude fly-by-night operators for whom credit provision would occupy a substantial amount of labor time. Several of the manufacturers required certain classes of client to pay a substantial proportion of the price when placing an order. A distinction was often drawn between firms and individuals; the former would be given credit but the latter would be required to make downpayments. For instance, a small metal manufacturer required individuals to make a 50% downpayment but gave credit to some firms. Another required individuals to pay 100% cash, and required new client firms to start off by paying in advance for their purchases, and then when sufficient trust had developed, permitted them some trade credit. As far as credit checking is concerned, most firms indicated that they relied on the character of the purchaser and normally required a considerable amount of information before starting a credit program. One small manufacturer mentioned that he gave credit to clients only after they had done business with his firm for at least a year. The motives for offering credit varied considerably. One manufacturer of window frames insisted that his firm was forced to sell on credit in order to prevent his clients from going to competitors. The owner of a small firm making ovens commented that he was more likely to offer trade credit when the market was stow. The metal manufacturers perceived contracts with the Ghanaian government as highly reliable, though at the cost of a delay in payment of at least two weeks, though more commonly four to six weeks. One manufacturer who did metal repair jobs commented that he granted credit mostly to public administrations (e.g. the police force) which did not have liquidity; credit, he commented, was the only way to break into that market.  58 C. Trade Credit Terms. Conditions and Motives The importance of trade credit in Ghana It has been shown in the literature review that trade credit plays an important role in U.S. manufacturing, particularly among smaller firms. In Ghana, the importance of trade credit is even greater. As the following paragraphs make clear, trade credit is both the most widely used and on average the largest source of outside21 finance for small firms, while for large firms it is overshadowed by finance from the formal banking sector. In Table 9, evidence is presented on the uses and sources of funds by the 1992 panel survey of 186 firms. The four trade credit items were obtained as follows. In the questionnaire. firms were asked to list their three main suppliers and three main clients. They were then asked how their purchases and sales were normally effected. the relevant options being casb, trade credit, advance payment, or consignment. It should be emphasized that this approach underestimated the total amount of trade credit in two ways. First, it did not count firms which usually dealt with their suppliers and clients on a cash basis, but whicb for some of the time used trade credit with the same suppliers or clients. Second. it did not count any suppliers or clients beyond the three most important ones. Third and most important, the survey done for the case study subsequently found that several firms had more trade credit than they had acknowledged in the panel survey. This underestimation of the extent of trade credit in turn had two causes: (i) transactions which had been reported as cash transactions in the panel turned out to be advance payment or credit sales on more careful examination; and (ii) more transactions were discovered and some of these took the form of trade credit. Hence the figures in Table 9 are underestimated and we shall proceed after examining them to the case study data which ought to contribute to a more accurate view of the phenomenon. The upper panel of Table 9 shows that accounts receivable are a frequent use of funds, with 38 of the 73 small firms, and 34 of the 41 large firms giving credit regularly to their chief clients. Loans to friends and relatives were not important and only large firms regularly made prepayments to their chief suppliers. 22 From the lower panel of Table 9 it appears that the commonest source of external funds for small firms was informal borrowing, with 31 of the 73 having borrowed from friends or relatives in the past year. The second most important source of external funding for small firms were accounts payable: some 29 of the 73 regularly purchased by means of trade credit. Prepayments were also important for small firms, with 26 of them regularly receiving prepayments from their most important clients. For large firms, formal bank finance was the most important source of funding: 24 of the 41 large firms had overdrafts. 21Insufficient data were available to compare the relative importance of retained earnings with external sources of funding. 22 Consignment proved to be rare except in the case of the few firms who regularly sold to department stores; this method of payment is not treated further here.  59 TABLE 9. SOURCES AND USES OF FUNDS OF GHANAIAN FIRMS: PANEL SURVEY, 1992: NUMBER OF FIRMS WITH NONZERO ITEM Small Medium Large Uses offunds Loans to friends 12 2 1 Make prepayments regularly 0 3 7 Give credit to clients regularly 38 30 34 Sources offund~ Have an overdraft 3 15 24 Borrowed informally in past year 31 22 5 Purchase regularly on credit 29 24 21 Receive prepayments regularly 26 32 13 Number of firms in sample 73 72 41 Source: 1992 panel survey of 186 firms in Ghana. aBank loans are omitted here, because the question in the panel survey covered only loans obtained in the past year, greatly underestimating the bank finance of large firms. To obtain greater precision it is essential to examine not only the frequency of use of various sources of finance (trade credit, overdrafts, informal borrowing, etc.) but also the size of the financial flows. The overall trade credit balances of firms were unfortunately not requested in the panel survey. Hence we turn to the smaller case study subsample (January 1993) to get an idea of the relative size of the fmancial flows. To begin with, we examine, in Table 10, the frequencies of use of the various sources of finance in the case study subsample. The subsample was selected on a stratified basis so as to focus mainly on the phenomenon of trade credit. Stratification was performed on the basis of whether or not the firm had any trade credit with any of its major suppliers or clients. Firms operating exclusively on a cash basis numbered 10 (small), 8 (medium) and 1 (large); of these two small firms and the one large firm were selected for the case study subsample. Firms with some trade credit numbered 63 (small), 57 (medium) and 35 (large); from these were selected 13 small firms, 13 medium-sized firms, and 8 large firms. To these were added, when in the field, a small number of suppliers and clients of the subsample who were themselves manufacturers. Among the small firms in the case study subsample, prepayments were the most common form of financing working capital, with 9 of the 15 firms interviewed having a positive balance of prepayments at the time. Second most widely used by the sample of small firms were accounts payable (six firms) and loans from friends and relatives (six firms). Among large firms, the three commonest forms of finance were accounts payable, bank loans and overdrafts (eight firms in each category), while prepayments from clients were somewhat less common (five firms).  60 Table 10. USES AND SOURCES OF FUNDS, SUBSAMPLE OF GHANAIAN MANUFACTURING FIRMS, 1993: NUMBER OF FIRMS WITH NONZERO ITEM Firm sizea Item Small Medium Large Uses offunds: Loans to friends 2 1 0 Prepayments made to suppliers 0 1 6 Accounts receivable 10 9 9 Sources offunds: Overdrafts 1 2 8 Loans from friends 6 2 0 Bank loans 1 2 8 Accounts payable 6 6 8 Prepayments received 9 7 5 Number of firms in sample 15 15 14 Source: January 1993 survey data. a Small = employment 0-10, Medium = 11-50, Large = > 50. As far as uses of funds are concerned, most firms, small and large, gave credit. Ten of the 15 small firms had positive accounts receivable, as did nine of the 15 medium-sized firms and 9 of the 14 large firms. None of the small firms had made any prepayments to other firms for which they were still awaiting delivery of the goods; whereas six of the 14 large firms had outstanding prepayments with other firms. One speculates whether there was some link between the large firms' ability to obtain bank funding and their willingness to pay in advance. Although six small firms had received loans from friends and relatives, onJy two gave loans to friends and relatives; and, not unexpectedly, personal ties leading to loans were unimportant among larger firms. Table 11 uses the same data set as that in Table 10, presenting the outstanding balances of the same financial items for the average firm. As has been seen, there was considerable variation across firms in their means of financing - many relying upon onJy a few of the five listed. Nevertheless, a few regularities may be pointed out on the basis of these aggregated data. Among small firms the most important source of funds was trade credit from suppliers: mean accounts payable amounted to 75 % of total outside finance, followed by prepayments from clients which accounted for 12 %2:l • 2:lWe have excluded from these calculations one firm with a substantial informal sector loan. The situation of this firm appeared to be exceptional as the firm was being propped up by assistance from  61 Among medium and large firms, bank finance (loans and overdrafts) were the most important source of funds. Taking loans and overdrafts together, bank finance accounted for some 76% of al1 outside finance of medium-sized firms (after excluding one firm with an unusually sized loan) and 82 % of all outside finance of the average large firm. The next most important source of funds, after loans and overdrafts, was accounts payable, for both medium and large firms. 24 TABLE 11. USES AND SOURCES OF FUNDS, CASE STUDY SUBSAMPLE OF GHANA MANUFACTURING FIRMS, 1993: PER FIRM BASIsa, BY FIRM SIZE Small b Mediumb Largeb Million Million Million Item Cedis Cedis Cedis % Uses offunds: Loans to friends 0.02 9 0.01 0.5 0 0 Prepayments made 0 0 0.3 15 to 9 Accounts receivable 0.2 91 1.7 85 99 91 Sources offunds: Overdrafts 0.07 4 1.4 16 63 7 Loans from friends O.06c 3.5C 0.2 2 0 0 Bank loans 0.1 6 5.3 d 6Qd 650 75 Accounts payable 1.3 75 1.2 14 126 15 Prepayments received 0.2 12 0.7 8 32 4 Source: Jan 1993 survey data. a The averages were created by dividing the sum of the particular financial item in each cell by the number of observations in the cell for which the financial item was known, including those for which it was zero. In a few cases the financial item was not known because the interviewee was unable or unwilling to reveal it. In these cases the missing firms were omitted from the calculation of the means. b See sizes in Table to. Excluding one firm with a large informal loan. Including C it, mean is 0800,000 and percentage 32 %. dExcluding one loan of C278m. Including it, mean is C26m and percentage 88 % . How do these conclusions change if one takes account of the stratification process? We conclude that the picture changes a little but not such as to alter one of the chief results, namely that the most indulgent relatives. If this firm is included after all, the mean loan figure is 0800,000, and the percentage is 32%. 24 Note that for these large Ghanaian firms bank loans were at least five times as important as accounts payable. For US firms (see the literature review, Table 3) bank loans were (3.1+1.1+3.7+13.1) = 21 % of all liabilities and equity, while trade debt was 9.5%; thus bank loans were about 2% times as important as accounts payable. It would be interesting to speculate on the reasons for this substantial difference in the relative importance of bank finance. One possibility is that large Ghanaian firms had relatively easy access to bank finance.  62 important source of outside funding for small firms is trade credit. As has been mentioned, two small firms were selected specifically because they claimed, in September 1992, to have no trade credit activity either with suppliers or with clients. It turned out, on closer examination, that both of them had some trade credit. One had positive accounts receivable and had received prepayments for goods not yet supplied; the other had positive accounts receivable and payable, and had received prepayments from clients.~ We adjusted the figures for small firms in Table 11 so as to take account of the stratification process. The results were barely distinguishable from the unadjusted numbers, with the percentage figures changing only in the decimals. In the following treatment of the functioning of trade credit in the Ghanaian manufacturing sector, various closely related subjects are dealt with. At first we attempt to examine the financial or liquidity theory of trade credit flows. Then we examine one of the important determinants of the terms under which trade credit (here understood as deferred payment) is offered, namely the production-cum-inventory cycle. We proceed to study the implicit interest rates involved in trade credit and finally discuss in detail the determinants of the length of the trade credit term. Next we discuss the use of advance payments. One of the causes of advance payment purchases is hypothesized to be illiquidity on the part of the seller. This is discussed in detail before dealing with the possibility that some advance payment purchases are caused by asset specificity (in combination with moral hazard). We then bring the deferred payment side and the advance payment side of the trade credit relation together when discussing the net trade credit position of manufacturing firms. Finally, we draw out several policy implications. The financial/liquidity theory or trade credit nows Do liquid firms offer trade credit to illiquid firms? An alternative way of stating the question is: Do firms with a low cost of finance lend, by means of trade credit, to firms facing a high cost of finance? In the presence of a substantial "trade credit multiplier", any funding granted by the banking system to the manufacturing sector would have a ripple effect extending well beyond the initial loan recipients. The trade credit multiplier has considerable policy importance, because a common form of assistance to industry is the provision of loans, often at low rates of interest and sometimes targeted at small firms. Most of these programs have not accomplished their objective of providing finance for small firms, mainly because the bankers who act as the intermediaries have been unwilling to grant loans to small and risky operations which lacked collateral in the form of real estate. Programs which have been targeted explicitly toward small firms have typically ended up granting loans to firms of medium and large size. If, however bank finance is in effect passed on by large firms to small firms through trade credit, then there is greater justification for loan programs by multilateral agencies to the manufacturing sector than has previously been believed. An econometric approach to the trade credit multiplier is infeasible because the number of observations is too small compared with the very large number of independent variables that would be required. The argument is therefore conducted by considering in detail both sides of certain transactions, ~Similarly, the large firm which had been selected because it claimed to have no trade credit with its major suppliers and clients turned out to have substantial accounts payable.  63 together with the respective entrepreneurs' own assessments of why they acted in certain ways - in other words the case-study approach. Three examples follow. Example #1: A small food manufacturer (9 employees) obtained trade credit for maize purchasers from two traders, one of whom (30 employees) was interviewed. The latter trader was highly liquid, having easy and swift access to bank finance, and having built up his retained earnings; the manufacturer, being small, had no loans from any source. In this particular case it appears that the trader's access to outside finance encouraged the expansion of the manufacturing business. This impression was reinforced by the interview with the trader, who emphasized that he had no choice in the matter: competition among maize traders was stiff and it was only by offering trade credit that he was able to stay in business. If this interpretation of the maize trade is accurate, a reduction in the cost of credit for the traders would result in a lower effective cost of (trade) credit with, ceteris paribus, a ripple effect tending to lower the manufacturers' output prices. Example #2: A large government-owned company in the food sector was under divestiture and consequently had no access to bank credit. The managers claimed that they were "forced" to use supplier credit to obtain raw materials. The supplier, who was also interviewed, had overdraft facilities and access to further bank credit through its mother company. Example #3: A metal manufacturer (28 employees) had some access to loans from friends and relatives, but claimed that he was expanding his firm and was planning to move to new premises. Being unable to draw in more credit, the firm resorted to supplier credit from its metal suppliers. (The firm also required some individuals to pay substantial amounts in advance; these prepayments, too, appear to have been motivated by the firm's need for liquidity. See below.) One of the suppliers, who was also interviewed, was a small trading operation without any access to bank credit. However, the trading operation was a part of a larger firm (13 employees) which did enjoy overdraft facilities. This is an interesting example of a liquid trading firm lending to a temporarily illiquid and larger manufacturing firm. These examples have shown that there is a link from the banking system to firms with the ability to borrow and thence, through trade credit, to firms incapable of borrowing. The case is, furthermore, buttressed by considering the linkage between illiquidity and purchase by advance payment. This is done in another section below. Trade credit terms and the production-cum-inventory cycle In competitive markets, producers can sell all their output at the going price. In oligopolistic markets, producers face a downward-sloping demand curve and have an incentive to use various techniques to move their goods: price manipulations, occasional or seasonal "sales", marketing and advertising, competitions, sponsorships, etc. Another means of obtaining a competitive edge is to offer trade credit, particularly to firms which face high finance costs or firms which are rationed out of credit markets. It is a reasonable guess that for many manufacturing sectors, oligopoly is the norm rather than perfect competition. If the assumption of ubiquitous oligopoly is accurate, firms will offer trade credit only insofar as it induces sales. The firm has no incentive to finance other activities of the client. The trade credit term will extend no further than the point where the goods in question have been processed and have been  64 converted into cash. The trade credit term may extend as far as the production cycle of the client, and may extend beyond this to the average inventory period of the client, but no further than this. As posed here, trade credit terms would be determined by the exigencies of the client only. In practice many other considerations would intervene. The desire for convenience and transparency would lead the supplying firm to seek to establish standard periods and terms based on the needs of the average client. For a large firm it would be too complicated to tailor trade credit terms to the needs of individual clients. Hence in practice the relationship observed between the length of the trade credit term and the length of the production-cum-inventory cycle will not be precise. Three examples are cited to illustrate the different ways in which there is a link between the trade credit cycle and the production-cum-inventory cycle in the case of Ghanaian manufacturing. Example #1, a close link: A small bakery received two to three days' credit on its flour purchases. The time in production was approximately one day. Allowing for some time for the flour to remain in inventory, and for some time for the finished bread to be sold to retail distributors, the trade credit period neatly coincided with the time that it took for the flour to generate revenue. A similar argument can be conducted with respect to another small bakery. Example #2, an unspecified term: There were several cases of unspecified credit terms in the sample. One is given here. A metal manufacturer bought on credit from four different suppliers. In the two examples of credit purchases which were noted down in detail, there was no prearranged credit term. The actual credit term in one case was seven days, and in the other two months. These credit terms were not driven by the production cycle which, it appeared, was about two days. The manufacturer commented that he paid when he had the money, noting that the supplier came to his plant from time to time to collect. There was an understanding that the credit was intended to help the manufacturer to sell, and so the credit period would cover the inventory period as well. Example #3, installment payments: A maize trader sold a consignment of C4 million to a client using an open line of credit. There was no specific term to repay the balance but the client repaid approximately c500,O<XJ each week for eight weeks. There was a cash discount of about 5% available which the client did not use. The trader had known the client for a year and a half. This kind of open line of credit is ideally suited to manufacturers with fairly predictable production and inventory cycles. As the output generates cash, the amount borrowed can be repaid so that the firm is not faced with the high costs resulting from cash flow problems. Motives for offering trade credit Of the 44 manufacturing firms in the January 1993 sample, 23 granted credit to at least one client. Of the 23, nine indicated that their motive for offering credit was sales promotion; four stated that their motive was to break into new markets; and ten advanced other motives. These various motivations are discussed in turn. Sales promotion: Some manufacturers revealed that they adjusted their sales practices depending upon the state of demand: during periods of high demand, advance payment or cash might be the norm, and during periods of low demand the manufacturer might grant credit in order to attract sales. One manufacturer of stoves said he used credit "when the market was slow". A smoked fish manufacturer said credit was used to get the goods moving in the high season or after a good catch. One textile firm  65 owner said he bought yarn for cash because demand was strong, and bought wicks and twines on credit because demand was soft. A clothing manufacturer said that the only way he could get his goods to compete with imported second hand clothing was by offering generous credit terms. A baker emphasized that he had no choice but to grant (very short-term) credit, because the retailers of bread did not have the money to pay cash. One firm owner said that credit was a means of retaining customer loyalty. A fascinating contrast emerged between several markets (fish, maize, flour, pineapples, lumber, foam rubber, scrap metal, iron bars and sheets) which were known to be highly competitive and one (aluminium) which was subject to a monopoly. In the competitive markets, trade credit was frequently granted. Several respondents claimed to have several suppliers of the same item, and to get trade credit from all of them; others mentioned only one supplier. In the monopolized aluminium market, on the other hand, there was no trade credit. Both firms buying from the monopolist had to pay about 50% of the price in advance, despite their long association with the supplier (six years and five years respectively), and despite their size (150 and 75 employees respectively) and their evident credit-worthiness. After allowing for local conditions, the aluminium firm is a textbook case of the monopolist who is expected to restrict output and raise the price. Since the aluminium firm does not lack for clients, it does not need to sweeten the pill by offering credit; instead it in effect raises the price in the sense that it requires its clients to bear the financial cost, the inconvenience and the risk of paying substantial amounts of money in advance. This contrast between competitive and non-competitive markets appears to undergird the motives for credit as stated by the respondents. Unfortunately the aluminium industry was the only monopoly included in the survey and so the deductions made above must remain tentative. Breaking into new markets: Some firms would offer trade credit in order to set up a distribution network. One stressed that the firm had used credit some years before in order to get the product known, but that by 1993 it was no longer necessary and all sales were conducted on a cash basis. One firm owner said that he once granted credit in order to obtain a market base, but that by 1993 he was less inclined to provide credit. However, he intended to use credit again when the firm introduced new products. A metal firm used credit "to help clients to expand" which "helps us all in the end". Other motives: A variety of other motives for granting credit were offered. Three firms felt that credit was "forced" upon them because checks would occasionally bounce, and people would pay late. Two firms which sold to public enterprises said that they had little choice in the matter since the public enterprises were short of liquidity. 26 Explicit and implicit cash discounts In the U.S. manufacturing sector, cash discounts are common and the formula "2/10 net 30" is a standard in many sectors. The imp1icit interest rates in credit transactions are high, typically much 26It should be borne in mind that not all sales to public enterprises were on a credit basis. The survey uncovered a few cases of advance payments being made by public enterprises; in one of the latter, the advances were part of a foreign financed development project.  66 higher than bank interest rates, with the "2/10 net 30" formula giving an interest rate of 43.5% (compounding every 20 days). The financial theory of trade credit can explain why the implicit trade credit interest rates are higher than bank interest rates. Liquid firms intermediate because their clients are rationed out of formal finance; their clients would be able to obtain loans only at even higher rates; and ongoing supplier/client relationships provide the supplier with crucial information on credit- worthiness which financial intermediaries lack. Not much research has been done to explain why most U.S. manufacturing industries have adopted one or other industry standard to determine trade credit terms. One possibility is that this was the industry's response to legislation against price discrimination. In Ghana, cash discounts are not standard. Of the 179 cash and credit transactions recorded in the January 1993 survey, in only 42 cases was there an understanding that a discount was available (i.e. that the cash purchase or sale would have cost more had credit been taken, or that the credit sale or purchase could have been effected at a lower price for cash). In the majority of cases, the respondent indicated that the question was irrelevant because the issue of an alternative (cash in place of credit or vice versa) did not arise. Alternatively, the respondent insisted that the price would have been the same if the alternative had been taken. It would be over-hasty to conclude from this that Ghanaian entrepreneurs suffer from money illusion. In some cases it appeared that either the interviewers had not communicated their concepts well enough, or that the respondents had misunderstood, because some respondents named a cash discount percentage and then remarked that it was a "bulk discount" or a reward to the client for being a regular customer. Several respondents said that the question about cash discounts was irrelevant because "we negotiate the price". This may have meant that they implicitly took account of the cost of finance and included it in the price, but it was difficult to discern the precise nature of their thinking. Language difficulties may have compounded the problem. These factors make it difficult for the researcher to put a precise value on the majority of the respondents' estimate of the time value of money. On the other hand, in the remaining 42 cases where a discount was available, the respondents appeared to have a clear notion of the time value of money and were quick to name the value of the discount. It is important to note that the infrequency of explicit cash discount terms is not because credit terms were unusual or because the firms were small or because the entrepreneurs were poorly schooled in economics. Several managers with high levels of education at the helm of large firms gave no cash discounts; while some entrepreneurs with small firms and no tertiary education did give cash discounts. Table 12 presents the implicit cash discounts calculated from all instances of credit transactions in which all the necessary data were present and in which the cash discount was positive. (Cash discounts named in the context of cash purchases could not be used because the term of the alternative credit transaction was unknown.) The interest rates should be interpreted with caution because it was found in the case study that the arranged terms of credit were frequently lengthened, resUlting in a lower effective implicit interest rate. It should be noted that in many cases the respondent said that there was no cash discount. These cases have been ignored in the subsequent analysis, on the assumption that there is an implicit price of credit because the seHer bargains the price each time and presumably charges a higher price for a credit transaction without necessarily making it clear that he or she is doing so. When buying from companies in developed countries, the purchases were denominated in dollars or other stable currencies, and the implicit annualized interest rates were closer to those observed more generally in the U.S., ranging from 4% and 34% (N=4). The interest rates involved in local purchases  67 were substantially higher, ranging from 27% to 14299% (N=7), as were those in local sales, which ranged from 37% to 2056% (N=6). The very high implicit interest rates arose from substantial discounts of 5% to 10% on short credit terms of one to four weeks. Table 12. IMPLICIT (ANNUALIZED) INTEREST RATES IN CREDIT TRANSACTIONS, SUBS AMPLE OF GHANAIAN FIRMS, 1993 No. of Pur- Bank % Term % Firm emplo- chase fin- dis- in interest no. Sector yees or sale ance? count days (annual) Foreign purchases: 200 Food 228 Pur Y 2 90 8 S200 Food 22 Pur Y 7.5 90" 34 S157 T&G 6 Pur N 1 90 4 S14 T&G 150 Pur Y 120 16 Local purchases and sales: 35 Food 32 Pur N 4.8 28 83 S35 Food 30 Sale Y 5 56 37 200 Food 228 Pur Y 2 30 27 64 T&G 27 Pur N 12 14 1819 64 T&G 27 Sale N 10 14 1100 140 T&G 4 Sale Y 7.7 30 146 73 Wood 54 Pur Y 10 60 79 166 Wood 27 Pur N 10 90 47 49 Metal 12 Sale N 12.5 14 2056 70 Metal 28 Pur N 10 7 14299 S70 Metal 2 Pur Y 5 42 53 S70 Metal 2 Sale Y 6.25 28 120 177 Metal 32 Sale Y 20 30" 819 Source: January 1993 case study survey data. a Prearranged term was 90 days; actual was 180, making an implicit interest rate of 16%. b Assuming a delay of 30 days, interest rate falls to 203%. Though credit terms were not standardized as they are in the US, two regularities may be discerned. First, there was a gulf between local implicit interest rates and foreign implicit interest rates, which can be explained by cross-country differences in inflation rates, interest rates, macroeconomic risk, and the risk of nonpayment. In the developed countries, inflation rates were in single figures and interest rates in the mid teens, the risk of severe macroeconomic disturbances was low, and since only carefully selected and large Ghanaian companies would be eligible for credit from overseas, the risk of nonpayment was minimal and the risk of late payment was low. In Ghana on the other hand, inflation ran to double figures in 1993, treasury bill rates were in the twenties, the risk of severe macroeconomic upsets was great (e.g. the fuel price leaped by 60% in January 1993) and among local companies the risk of nonpayment was nonnegligible and the risk of late payment high. Second, there was a relation between the firm's access to formal bank finance and the implicit interest rate it paid on its credit purchases. In Figure 3, firm size (represented by employment) is plotted  68 against the implicit interest rate, and the firm's possession or otherwise of overdraft facilities is indicated by Y and N. It is improbable that firm size per se determines the implicit interest rate, since both small and large firms have relatively low interest rates, while some medium sized firms have extremely high implicit interest rates. It appears, however, that the access of the firm to formal banking finance determines the implicit interest rate. In the upper half of the graph are four firms27 with interest rates in the range 800%-14000%: of these all but one have no overdraft facilities. In the lower half of the graph, seven firms have interest rates in the range 27%-146%; of these five have overdraft facilities. Figure 3. IMPLICIT INTEREST RATES AND ACCESS TO BANK FINANCE 100000 . - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - . . . . , (J) 10000 - +oJ It) I- +oJ N (I) N (l) I- (J) * '!lIE N +oJ ,*,v e 1000 l- +oJ '* !.) v ~ y lIE 100 '- '*' N Y lIE lIE Y '!lIE 10 ~----------~---------~---------~ ~ 10 100 1000 Errp I oyrne.nt These data are consistent with the theory that firms without suitable collateral, being barred from formal banking finance, face a prohibitively high cost of capital and are therefore both prepared to pay very high interest rates to obtain trade credit and will charge very high interest rates on credit given.2l! Another explanation for the patterns observed is that both variables (overdrafts and interest rates) are determined by a third factor: their perceived reliability in payment. If they are perceived to be risky customers (perhaps because their firms were small, new, in volatile markets, etc.) they would be given 27 One of which has two transactions. 2l! Some firms had access to loans from relatives and friends, and these were typically on highly favorable terms in that interest was rarely charged and there was frequently no specific term for repayment, let alone a penalty clause. Yet the true cost of informal loans was probably substantial, for taking a loan probably implied a moral obligation to give loans on similarly favorable terms later.  69 only very short credit terms (and hence high implicit interest rates) and they would also find it difficult convincing bank managers of their credit-worthiness. TABLE 13. FREQUENCY DISTRIBUTION OF THE LENGTH OF TRADE CREDIT TERMsa, BY FIRM SIZE, SAMPLE OF GHANAIAN FIRMS, 1993 Trade credit term length (days) Employment 1-7 8-14 15-30 31-60 >60 Purchases: 0-10 8 4 0 5 0 11-50 4 2 1 1 4 > 50 0 1 4 2 3 Sales: 0-10 6 3 4 4 2 11-50 2 4 7 2 0 > 50 1 2 4 5 2 Source: Jan 1993 case study survey data; including suppliers, clients and traders. a Prearranged or actual, whichever was longer. Length of credit terms In a sample of U.S. manufacturers in 1987, the mean trade credit term length was 49 days for purchases and 63 days for sales (Long et aI., 1992, Table 2). The sale credit term was longer than the purchase credit term, reflecting the fact that U.S. manufacturing was on average a grantor of trade credit. In Ghana, the mean (median) term for purchases in the January 1993 sample was 50 (30) days, while the mean (median) term for sales was 32 (30) days. The mean term for sales was substantially less than that for purchases, reflecting the fact that this small sample of Ghanaian firms was on average a net recipient of trade credit. The tendency of Ghanaian firms to borrow long and sell short reflects several factors. (i) Illiquidity: it may have been an adaptation to the scarcity of capital and the inability of many firms to borrow through the banking system. Trade credit may have substituted for finance from the banking sector. (ii) Moral hazard: it may have reflected the fact that the reliability of many of the clients was in question (e.g. small firms, traders with no fixed place of work). (iii) The length of the borrowing terms was exaggerated upwards by a few cases in which purchases from overseas were effected with very long credit terms.  70 Tabl e 13 presents a frequency distribution of credit term lengths of the firms in the January 1993 sample, by firm size groupS.29 It appears from the upper panel (purchases) that smaller firms had shorter credit terms, as one would expect if smaller firms were perceived to be unsure risks. A much larger sample of firms would be needed to perform thorough multivariate tests of this hypothesis. In any case, two small bakeries each with fewer than 10 employees purchased flour on credit lasting from two to four days. It is not clear whether these very short terms were due to the liquidity needs of the suppliers, or the perceived unreliability of the bakeries30 , or to the perishability of the inputs or outputs, or to the length of the production cycle of bread (see the section on the length of the credit term and the production-cum-inventory cycle). Finally, some small firms had credit terms of as long as eight weeks e.g. one firm bought maize from a trader, paying the latter back in four fortnightly tranches. It appears from the lower panel of Table 13 (credit sales) that smaller firms sold shorter than large firms. There were exception, however. For instance, one large firm which would have had no difficulty in arranging bank loans had a policy of selling on only a few days' credit, even to traders of long standing. Table 14 presents the frequency distribution of the length of credit terms by the length of the relationship of the firm with its suppliers and clients. The sample here comprises all 44 manufacturing firms, viz. 39 firms from the original panel, plus five firms which came in as suppliers and clients. Non- manufacturing firms, viz. traders, are omitted. Intuitively one would expect to see some correlation between the length of the credit term and the length of the relationship. The latter could proxy for the probability of timeous repayment. It is not obvious, however, from Table 14 that any such relationship exists. It may be that the crucial decision regarding trade credit is whether the client is trustworthy or not, and this may depend upon the length of the relationship; but once having decided that the client is credit-worthy, the terms of the trade credit contract may be worked out using other criteria. The nature of the product and the production process may be a determinant of the length of the credit period. A baker's turnaround time is a day or two and unsurprisingly the three bakers in the January 1993 sample had credit periods of two to four days; the turnaround time for furniture and ovens is of the order of weeks and so the raw materials for these products - lumber and metal sheeting - attracted credit terms of a few weeks. This subject has been discussed at length in the section on trade credit terms and the production-cum-inventory cycle. 29 For convenience only one term is considered: the longer of the prearranged term and the actual term. Subsequently an analysis will be conducted of the differences between the prearranged and actual terms. 30It may be possible in due course to compare the trade credit activities of these small bakeries with those of large bakeries. Unfortunately there were no large bakeries in the January 1993 sample.  71 TABLE 14. DISTRIBUTION OF LENGTH OF TRADE CREDIT TERMSa, BY LENGTH OF RELATIONSHIP WITH SUPPLIERS AND CLIENTS, SAMPLE OF GHANAIAN MANUFACTURERS, 1993 Length of Trade credit term (days) relation- ship (mo) 1-7 8-14 15-30 31-60 >60 Purchases: 2-6 1 0 0 0 0 7-24 3 3 1 1 1 25-48 2 1 0 0 2 > 48 3 1 4 2 2 Sales: 0-1 0 0 1 2 0 2-6 0 1 0 1 0 7-24 1 1 1 0 0 25-48 1 1 2 2 0 > 48 2 2 4 2 1 Source: Jan 1993 survey data; manufacturers only, excluding traders. a Prearranged or actual, whichever was longer. Motives for advance payment sales There are at least four reasons why manufacturers might require clients to pay all or pan of the price of an item upon order (and the remainder upon delivery or later). The first reason for requiring downpayments is illiquidity. The manufacturer may have hislher money tied up in plant and equipment and the wage bill; alternatively, the manufacturer may be subject to temporary illiquidity on account of plans to expand, demand or supply shocks, or shocks to the family finances. The second reason for advance payment sales has to do with asset specificity: if the good being ordered is specialized for the client's needs, its salvage value could be far less than the arranged price if the client reneged at the last minute. (There is a moral hazard element here as well in that a reputable and liquid firm would not renege.) The third reason for advance payment sales has to do with what might be termed 'pure' moral hazard: assuming no specificity in the product, the manufacturer may still wish to bind the client by requiring a down payment. The costs of having a large item in inventory could be considerable if the product takes a long time to move. The final reason for advance payment, which might be termed the 'strategic' reason, has to do with seasonal demand fluctuations. Fearing price increases and stockouts during a future period of high demand such as Christmas, customers give downpayments to the manufacturer in order to be sure of  72 getting the product timeously and at a lower price. For instance, one baker bought flour by advance payment over the Christmas period. It should be stressed that in the following empirical treatment we do not attempt to exclude one or other possible cause of advance payment sales; nor are we in a position to quantify the relative contribution of each factor to the establishment of the institution of advance payment. At this early stage in the study of trade credit our main concern is to establish that there are a variety of causes, and to give the reader a flavor of the phenomena that appear in the course of intensive survey work. In the following pages we discuss the first two causes of advance payment: illiquidity and asset specificity. The other causes ('pure' moral hazard and strategic advances) are of lesser interest and are omitted. Illiquidity as a cause of advance payment sales The relation between illiquidity of the seller and advance payment sales is best approached by means of a few examples. Care is taken in these particular cases to demonstrate that none of the other motives for advance payments sales is operative, so that we are left with illiquidity on the part of the seller as the prime motive for this institutional form. Example #1: A garment firm was experiencing vigorous seasonal demand for uniforms but had difficulty satisfying the demand due to a lack of finance for purchases of fabric. The firm received fabric on credit from an intermediary which set an upper limit on its credit sales which had already been reached. The firm could not approach the fabric manufacturer directly because the latter sold only in very large quantities against cash. Faced with cash flow problems, the manufacturer of uniforms recently started requiring some individual customers to pay in full in advance. Example #2: A metal firm had no overdraft or loans from any source. The firm made and sold various metal products. The client which brought in the most revenue was a large multinational which did not make any payments in advance. The metal firm required individual customers to make substantial downpayments, often as large as 50%; the amount of the downpayment, according to the owner, was negotiated according to the liquidity of the firm. Recently the firm sold a gas oven for C450,OOO, after requiring a downpayment of ClOO,OOO. The oven was not specialized for the client's needs, so the firm's reason for requiring a downpayment did not arise from asset specificity. The price of the oven was some 2.5% of annual sales and would have sold quickly if the customer who laid the order reneged on the deal; so the motive for requiring a downpayment did not arise from the moral hazard of being landed with a lumpy slow-moving inventory item. Thus it appears that this particular prepayment was motivated by the firm's need for liquidity. Example #3: One metal manufacturer had been unsuccessful in obtaining bank loans and overdrafts, although the firm did have a loan from a friend of the owner. Furthermore, the firm was expanding and had plans to move to new premises in the near future. Thus the firm appeared to be illiquid. On the input side, it relied on supplier credit to satisfy its working capital requirements. On the marketing side, it sold some of the gates it produced by means of substantial advance payment. While the gates may have been somewhat specialized for the customer's use, they would probably have been readily saleable if the deal had fallen through. (The firm also held inventories of gates.) Thus the asset specificity motive did not seem to be important. The value of the gate, at ClOO,OOO, was only some 0.7% of the firm's annual sales and so the moral hazard of being stranded with a bulky inventory item did not seem important. In sum, the liquidity motive for prepayment appeared to be the most important for this purchase by this manufacturer.  73 Asset specificity and advance payment purchases As has been stressed in the literature review, one can imagine a continuum of products ranging from those with great specificity to those with none. At the asset specificity extreme, firms are likely to require downpayments because if the client reneges the articles have low salvage value. At the opposite extreme where articles are completely general and have a high salvage value, cash payments are likely to be the norm and inventories may be held in order to adapt to fluctuations in demand and to prevent stockouts. Between the extremes of complete specificity and complete generality, there is a wide range of articles which might or might not be custom-built, depending on expected demand levels and on the availability of finance to hold inventories. If demand is expected to be high and constant, and the firm has sufficient liquidity from savings or loans to build storage facilities and hold inventories, then the firm's output is likely to be sold for cash. If on the other hand demand is expected to be sporadic and the firm is plagued by problems of illiquidity, then custom-building is the likely result, with advance payment being required not so much for reasons of asset specificity but to protect the producer from the moral hazard of repudiation which would entail unwanted inventory costs. In Ghana advance payment was standard in the context of custom-made articles. This was particularly the case in the textile and garment sector and in the wood sector. The trousers made by a small garments manufacturer were obviously made to fit individual clients' needs and tastes and could not have been sold readily if the client reneged. Similarly sets of wicker chairs, and household furniture items could not have been sold easily if the clients failed to pay for them upon completion. Uniforms made by one garment manufacturer for a public enterprise could not have been disposed of if the client refused to collect the goods and pay. The same applied to dresses sold on advance payment by a firm which did a good deal of custom tailoring. The latter owner commented that some people came to his firm because they were unable to find their own size in the available stocks of imported dresses. Other instances of custom building entailed near-total asset specificity. These included large contracts for woodwork for a particular building serving the particular needs of the client. For instance, one firm in the wood sector made arrival hall furniture for a hotel under a contract lasting for a year. As expected, a downpayment was required. At the other extreme were products with entirely general characteristics: bottled orange juice, bottled soft drinks, ice lollies, tinned juice, chocolate, school uniforms, ovens, and window frames. These articles were uniform, small, and not custom-made. Accordingly the issue of downpayments did not arise; they were sold on credit or for cash. Combining deferred payments and prepayments: net trade credit positions As was pointed out in the literature review, the U. S. manufacturing sector was on average a net grantor of trade credit in the 1970s. In Ghana the opposite would seem to be the case. Table 15 summarizes the net trade credit positionll of all the firms, by category, for which all the necessary data 31 The following convention is adopted here. Net trade credit is defined as accounts payable + prepayments received from clients - accounts receivable - prepayments made to suppliers. If net trade credit is positive (negative), the firm is deemed a net trade credit recipient (grantor).  74 were available, from the sample interviewed in January 1993. The numbers must be interpreted with caution because the sample size was small and because the net position of firms can change frequently. One respondent showed the author the firm's accounts receivable and accounts payable, which indeed varied greatly from month to month. These caveats aside, three of the four sectors (food, wood, metal) of the manufacturing firms have a preponderance of net trade credit recipients. Most of the small and unrepresentative sample of suppliers were net grantors of trade credit, as were the traders, and the sample of clients comprised mostly net recipients of trade credit. TABLE 15. NET TRADE CREDIT POSITIONS, GHANAIAN FIRM SAMPLE, 1993 (NUMBER) Firm type/sector Recipients Grantors Food 5 3 Tex. & Gar. 4 6 Wood 7 2 Metal 4 3 Suppliers 3 6 Clients 3 1 Traders 1 3 Source: Jan 1993 survey data. Net trade credit = accounts payable + prepayment received - accounts receivable - prepayment given. In the wood sector, net trade credit recipients outnumbered net trade grantors 7 to 2, due to the predominance of prepayments, which, as discussed elsewhere in this paper, has to do with asset specificity, moral hazard, and the relative size of orders. It is interesting to speculate on why the manufacturers tended to be net trade credit recipients and traders tended to be net trade credit grantors. It may be that manufacturers tied up their resources in plant and equipment and were therefore dependent upon trade credit as a means of obtaining the necessary liquidity for the day-to-day running of the firms; whereas the group of traders was selectively composed of entrepreneurs who had been successful, through borrowing or saving, in commanding the resources necessary for flexible and speedy financial dealings. It is interesting, further, to speculate on why the manufacturing sector in the U.S. was a net trade credit grantor while that of Ghana appeared to be a net trade credit recipient. Two reasons might be advanced32 • 32 Note that the mere fact that credit checking agencies were common in the US but absent in Ghana does not, on its own, explain why US firms were net trade credit grantors while Ghanaian firms were net trade credit recipients. Cheap and speedy credit checking in the US probably helped US firms to grant more trade credit, but also to get more trade credit, than they would have, ceteris paribus, in Ghana.  75 (a) U.S. manufacturers may have sold a greater proportion of their goods to other firms, whereas Ghanaian manufacturers may have sold a greater proportion of their goods to individuals. Relations with client firms were likely to be of longer standing than relations with individuals, and more information would have been available about client firms than about individuals; and so U.S. manufacturers may have been able to provide proportionally more credit to clients than Ghanaian manufacturers. (b) Perhaps the U.S. manufacturing sector was more liquid, as most firms, being in possession of some collateral, had easier access to bank finance, and firms accordingly competed through, among other things, providing finance to clients. Meanwhile smalP3 Ghanaian firms, being credit-constrained owing to their lack of reputation and collateral, resorted to the expensive means of trade credit to obtain their working capital. This prompts the question: if the difficulty of obtaining finance is what drove Ghanaian manufacturing firms to rely on trade credit, why did trading firms in Ghana not do the same? Although this is highly speculative, the answer may lie in the trading firm's relatively greater need for flexibility. Whereas a manufacturing firm might ultimately derive the greater part of its profits from quasi-rents on its scarce resources (creative skill, noticing market gaps, superior organizing ability) the trading firm might rely ultimately on its facility in spotting and exploiting profitable short-term trading opportunities. For instance, traders might be skilled in seeking out manufacturers who are willing to pay substantially higher prices in return for short-term credit. Thus labor market specialization may be the factor which ultimately determines net trade credit positions: those with scarce manufacturing skills would specialize in manufacturing and borrow, while those with scarce financial skills would specialize in trading and lend. D. The Nature and Enforcement of Trade Credit Contracts As has been described above, trade credit plays a significant role in the Ghanaian economy. Trade credit is a kind of contract, which, when breached, results in losses. Thus, when examining the contracting environment in terms of trade credit and enterprise finance, it is important to focus on how contracting behavior either promotes or hinders firm finance. In other words, an appropriate focus for contract enforcement is the losses that poor enforcement incurs. This section addresses the problem in this way and, consequently, seeks to recommend policies designed to recapture such unnecessary losses. A more general description of contracting behavior may be found in the appendix. A series of questions was asked to respondent firms regarding problems they encounter with suppliers and clients. The questions were mostly open ended and answered conversationally. Answers were recoded after the interview to incorporate into the analysis elements of information that had been collected in an informal way. Firms were stratified into suppliers, panel firms, and customers as well as between traders and trading firms and manufacturing firms. Panel firms were also divided by sector. The sample of recorded answers is small (around 60 firms) and qualitatively diverse, making it difficult to draw statistically significant inferences. Reported numbers, therefore, should be interpreted with care. In the analysis, however, it was possible to combine the coded answers with qualitative information collected during the interviews to paint a broad brush picture of contract enforcement problems in Ghana. General observations are made here; detailed results of the interviews are found in the Annex. 33 Note that, as emerged from a previous table, large Ghanaian firms did not appear to have difficulty in obtaining bank finance.  76 1. Causes for Breaches of Contract In order to evaluate how breaches of contract are treated (by parties as well as the state enforcement mechanism), it is first necessary to understand the reasons for breaches. Breaches can be divided into two general categories: unavoidable and avoidable. Unavoidable breaches refer to breaches that are not within the control of the breaching party; that is, he is willing but unable to perform. Avoidable, or opportunistic, breaches are intentional; the breaching party is able, yet unwilling to perform. Anyone who extends trade credit exposes himself to the risk of each kind of breach. Contract law, the law of security interests, and to some extent criminal law, is able to minimize the risk of breaches by creating disincentives. The effectiveness of these mechanisms will depend upon their relative costs. "Unavoidable" breaches. Enforcement tends not to be an issue with these kinds of breaches. Buyers often tend to breach their payment responsibilities due to alleged economic difficUlties. This occurred in two thirds of firms in the case study, most frequently in the textile and garment sector. Breachers claim illiquidity due to either an inability to sell their own goods or non-payment by their own clients. These excuses essentially pass their risk on to the original seller of inputs. In western countries, this would not justify non-payment unless the conditions had been negotiated in the contract itself (Le. if the contract had been explicitly "state contingent"). This is so because western countries have more fluid capital markets, meaning that owers of money are expected to borrow from the capital market in order to pay their debts, regardless of their economic situation. 34 In contrast, Ghanaian trade credit contracts appear to be presumed "state contingent." That is, given Ghana's thin markets for goods and capital, most sellers on credit assume that the promise to pay is contingent on availablity of funds. Even if such an assumption were not made, enforcing payment obligations against a moneyJess debtor would be a dead-weight cost, because there would be nothing to collect in the event of favorable judgement.3s In 1ight of these constraints, sellers usually accept the loss incurred due to a breaching buyer and refuse to grant credit to that buyer again. Suppliers tend to breach delivery obligations due to scarcity of either the goods themselves or the funds or credit to purchase them. Non-<telivery is a moderately frequent problem, accounting for around 25% of all deliveries. Because scarcity tends to be the cause of breach, many buyers perceive that a prompt remedy would not be forthcoming if they were to formally demand performance. As a result, 34 It is important to keep in mind, however, that even in western business relations, strict enforcement is at the discretion of the parties, and may be avoided if the creditor understands the debtor's current economic situation and future prospects. 3S Of course, a long-term payment schedule could be formally worked out in court, but this may be (and is) done privately at a lower cost. Similarly, while it may be possible to substitute goods for money for repayment, such a solution would not succeed in Ghana for three reasons: destroying someone else's business by repossession is shameful, it could prevent the business from earning the money needed to satisfy the debt, and it is expensive for the creditor (he must run or sell business to recoup his losses). One businesswoman had actually received a judgement against a client debtor, enabling her to foreclose on his home. She refrained from doing so, however, apparently out of a sense of shame at throwing old people out in the street.  77 most clients are forced to wait for their inputs, especially if they had purchasing on credit and don't have the cash required to buy from another supplier (often a stranger). Late or incomplete delivery of inputs, however, accounts for around one half of all deliveries and is usually attributed to the supplier's inability to acquire the input themselves. Delays in delivery are usually short (a few days) and thus there is little need for enforcement, even in cases where some or all payment has been made in advance. Late delivery is usually due to difficulties in acquisition or transport of the goods; lateness is therefore anticipated and wouldn't be considered grounds for enforcement. Qpportunistic breaches. As stated above, an opportunistic breach describes an intentional dishonoring of a contractual obligation that is motivated by personal gain.36 An efficient, market- oriented law would allow opportunistic breaches to occur, provided the breacher pays damages to the original contractor, enough so to place him in a position equivalent to that as if the contract had been performed. This is meant to produce aggregate efficiency in that 1) the original contractor is no worse off, as he has been compensated (which may include opportunity costs), 2) the breacher has sold his goods at the highest available price, and 3) the new contractor has received the goods he bargained for. In Ghana, such damages are recognized by the body of formal laws and awarded in court. However, it is doubtful that such damages are recouped through informal enforcement mechanisms. Unlike the losses attributed to economic hardship and scarcity (discussed above), which are more difficult to compensate for, losses caused by opportunistic breaches will help recoup losses that severely distort the contracting environment and that shrink the scope of trade credit and transactions among anonymous parties. Thus, enforcement here is both warranted and feasible because 1) a party has been intentionally harmed, and 2) there is money or property to be collected. Buyers in Ghana appear to intentionally breach their payment obligations in one out of three cases. The occurrence is most common in the timber and wood products industry. This makes sense, as it is a fluid, competitive, and lucrative industry, meaning demand is higher (so sellers will have more opportunities to sell at a price higher than the original contracted-for price) and supply is also high (meaning buyers, if breached upon, can seek alternative inputs in the market, albeit at a higher price). Buyers who tend to breach opponunistically are usually about to move away from their towns and therefor exploit their credit facilities to the maximum before disappearing forever. Unless the defaulting buyer can be found after he or she moves, there is little that enforcement measures can do in such cases. End-users are more likely not to honor payment than other firms are, presumably because they have less interest in long-term relations. A few exporters claimed that foreign buyers would take advantage of the distance and complain about the quality of goods before payment. 37 Similarly, informal inter-African trade is also risky, as enforcement mechanisms are virtually non-existent. Sellers face similar incentives to breach opponunistically; where demand is high. they may be tempted to breach one promise in order to gain from another. 36 An example would be one who breaches a supply contract in order to sell the same supplies to another buyer at a higher price. 37Of course, as we heard only one side of the story, it is always possible that the goods were, in fact, deficient quality.  78 2. Flexibility versus "Hard Contract" Constraints As we have seen, the enforcement of contracts between Ghanaians remains flexible, in order to accommodate the conditions of scarcity, illiquidity, and low income levels. Furthermore markets for raw materials, intermediate goods, specialized services, and capital equipment are thin or non-existent. Alternative sources of supply often do not exist. Whenever technical difficulties or shortages of imported goods arise, they cannot easily be circumvented and tend to ripple through all downstream economic activities. These factors combine to create delivery, payment, and quality problems. Consequently, compJiance with contractual terms is made difficult, making insistance on adherence to contracts between Ghanaian firms unrealistic. The flexible enforcement of contracts is thus a natural consequence of the level of development attained by the country. It is unlikely to disappear before the manufacturing sector has grown so that firms maintain enough I iquidity to enable them to honor their contracts by accessing various sources of supply or capital. Institutions aiming at the indiscriminate and textual enforcement of all contracts would undoubtedly put many Ghanaian firms at risk of extinction. It is important to remember. however. that the essence of contract flexibility IS In the voluntariness ofbusinessmen in enforcment of contracts. In other words, contracts between private parties are enforced by their chosing, not by an intrusive external institution. Therefore, reform in this area would not require entrepreneurs to enforce contracts they chose not to enforce. Rather, reform would aim to provide low-cost relief to those who are predisposed to seeking formal enforcement. This is usually a self-selected group who believes 1) they have a valid claim and can win a favorable judgment, and 2) they can actually collect their damage award. Even if enforcement institutions were made more accessible, firms in Ghana, as elsewhere in the world, would continue to conduct most of their business on the basis of inter-personal relations and trust. Additionally, since many Ghanaian firms are small and undercapitalized, insolvency is likely to continue to hamper repayment for a long time to come. In light of these factors, the focus of policy recommendations should be on enabling firms to conduct at least a portion of their business with other reliable firms and individuals with whom they have had little or no prior business experience. This would extend the economic reach of firms and consequently improve economic efficiency and foster the development of a dynamic business community. One may fear that making court action cheaper would make legal action against poor and insolvent debtors more likely. This fear appears largely unjustified, however. First, creditors would be very unlikely to initiate court action, even at a reduced cost, against an insolvent debtor because they would have nothing to collect (Le. such debtors are "judgement-proof'). Second, creditors would be equally unlikely to initiate court action against a commercial debtor with whom they wish to continue doing business and for whom they have good reasons to believe that they will eventually be repaid. This leaves opponunistic firms and individuals who are not insolvent as the most likely targets of coun action injront of small claims couns. These are the very actors that should be enforced against, as they impose needless costs on the contracting system. By reducing the cost of going to court, action against opportunists would be more likely, the threat of court action by the creditor would be more credible, and opportunistic breach of contract would be deterred. Ultimately, this could lead to the increased frequency of transactions between strangers, which would broaden markets and move the Ghanaian economy towards achieving greater efficiency.  79 3. Risk Assessment as Constrained by Lack of Information Ghanaian businessmen assess risk using similar information as is used by western businessmen, albeit on a much more limited scale. This entails determining the vitality of the buyer's business, his creditworthiness, his reputation, and sometimes even his financial accounts. 38 Much of this is done informally between commercial partners. For example, before extending credit to a potential client, some sellers will drive by the client's business and possibly his home, in order to roughly assess the individual's success. 39 At the business (and sometimes home) site, a prospective granter of credit will interview employees in order to determine how many and how often other creditors come to the premises to collect overdue debts. In addition, informal (and illegal) credit checks are performed by bank employees in exchange for side payments from friends. These inquiries reveal existing lines of bank credit, the frequency of bounced checks, and the regularity of deposits and withdraYfals. When such credit checks are found satisfactory, respondents were more likely to extend supplier credit, even to previously unknown customers. This indicates that a commercial credit rating service could be relied upon by .conunercial actors, which may be the quickest way of extending credit access beyond the circumference ofpersonal acquaintances to purely market-driven economic transactions. The support of a credit rating agency in Ghana is discussed further below under "Recommendations." 4. Current Modes of Contract Enforcement in Ghana Contracting in the private sector means that individual economic actors are free to enter into bargains they expect to be profitable. This freedom includes the freedom to measure and assume risks, and the burden of suffering those risks. If a government wishes to encourage individuals to enter into such contracts, it will foster a contract regime that protects the reasonable expectations of contracting parties. This preserves individuals' freedom to calculate their own risks while simultaneously protecting them from opportunistic and fraudulent behavior of their contracting partners. Ghanaian contract law, which is based on British common law, embodies contract principles that foster a stable contracting environment. However, the formal enforcement system (Le. the courts) tends not to be used by manufacturers and traders in Ghana. The main reason for this is the perceived cost of going to court, which includes the businessman's time spent in court, court fees, lawyer's fees, and depreciation due to inflation and currency devaluation. Another cost is the loss of the other party's business, which tends to result from bringing a formal action. For a formal action to be profitable, these costs must be lower than the amount recovered. Thus, the decision to enforce a contract begins with assessing the likelihood of recovering the contract price. As was stated above, a major cause of breach of contract is due to either illiquidity or scarcity; in other words, non-payment is often due to inability to pay, and non-delivery is usually due to inability 38 Analyzing the financial records of a potential client is less common, not only because such records could be unreliable, but also because such a request could be seen by many Ghanaians as an act of bad faith that would preempt the development of a healthy business relationship. 39 While many businessmen rely on this method, it should be pointed out that, in light of the large underground economy (once estimated at 40%), such outward appearances could be deceiving, resulting in adverse selection of credit sales.  80 of the supplier to either locate or purchase supplies.40 When this is the case, and this is known to the party to whom performance is due, seeking enforcement would be a fruitless venture, since the costs could conceivable outweigh the amount recovered. Consequently, respondents admitted not to enforce contracts breached for this reason, because they realize that inability is preventing the other party from paying, not bad faith. In contrast, enforcement does become an issue when contracts are breached for reasons not attributable to economic forces and the breacher has assets that the aggrieved party can collect. For those who seek to collect their due, efficient enforcement mechanism should be available. Formal enforcement mechanisms The formal court system. In Ghana, as in many economies, enforcing a contract in court entails costs that many Ghanaians are unwilling to incur. These include the entrepreneur's time spent on preparation and in court, lawyers' fees, court fees, damaged reputation (suing is seen as the ultimate hostile act), and the resulting lost of business. Another, less tangible, disincentive to using the court system involves those contracting with the government, which habitually pays late. Our respondents were unwilling to discuss the subject, but one lawyer observed a general perception that government contracts are unenforceable against the government. The Ghanaian government is the biggest contractor for products and services, and few entrepreneurs could afford to sever that link. Furthermore, the process for suing the government is even more protracted than a private suit, requiring the permission of the Attorney General (see the State Proceedings Act). This acts as a further, albeit political, disincentive to seek enforcement in a court of law. 41 Lawyers' fees are seen as too high, running roughly 10%-15% of the amount in controversy. This alone, however, might not dissuade one with a good case, as Ghana follows the British rule on legal fees, which requires the loser of a law suit to pay the winner's court costs and attorneys' fees. Court fees have recently increased up to 200%, but they still maintain a reasonable proportion to disputed amounts. 42 Those who do sue for breach of contract in court tend to sue for non-delivery or non-payment. Amounts in controversy range from 1 million to 10 million cedis and average at 5 million cedis. One lawyer estimated that 10 years ago the minimum value of a claim worth enforcing in court was 10,000 cedis; today it is 500,000 cedis. 43 40 This section does not deal with late payment or late delivery, as the response in these cases tends to be simply to wait for performance. The concept of "damages" due to lateness has not become part of the contracting culture in Ghana, and is therefore not discussed in this section. 41 It is noteworthy, however, that foreign private companies have sued the Ghanaian government; indeed, in Ghanaian courts, attesting to the perceived objectivity of local judges. 42 For example, the fees for a claim of 500,000 cedis (around $890) could amount to c. 6700 ($12 or 1. 35 %). To appeal such a case would be more expensive, total ing possibl y c. 10,000 ($18 or 2 %). See the Civil Proceedings Rules (Fees and Allowances Amendment), 1992, L.I. 1540. 43 All of these figures are rough guesses.  81 Perhaps the major complaint against the courts is the length of time it takes to pursue a case from claim to judgement. The length of time between non-payment and judgement for an average case could . take around 18 months and can be illustrated as follows. A party may wait up to six months for payment. He will then ask a lawyer to to draft a letter indicating that, if payment is not made in two weeks, he will bring a formal court action. This is usually enough to receive payment from a recalcitrant payer. If this fails, however, in two weeks another lawyer's letter is sent, announcing the commencement of a legal action. The case will then go to court, and judgement will be pronounced within 3-6 months (for vigilant plaintiffs).44 Thereafter, it can take up to six months to actually receive the written judgement, which is necessary for its enforcement. One explanation for this delay is that everything is handwritten. Judges record evidence by longhand, which takes time and increases the probability of mistakes. This in turn leads to corrections, thereby further increasing time. Judges have no clerks to assist them in this task, nor in researching law before drafting opinions, which is an industrious process in a common law country, where cases govern contract law moreso than more concise statutes.43 To address this delay in receiving judgement both computers or stenographer machines are needed. Assistance in this area would greatly benefit the commercial sector at a low cost, with the added benefit of raising the skills level of court staff through training and technology transfer. Formal arbitration. Arbitration is "a form of dispute resolution that occurs outside the formal court system but whose decisions are binding and enforceable by the state. Arbiters tend to be trained in law, but may also be experienced in business matters. The Arbitration Act (#38) of 1961 governs formal arbitration in Ghana. Its use in practice is limited, however, mainly because the parties must agree to formal arbitration, including specific arbiters, at the time of the contract. This rarely occurs, not only because most contracts are oral (and therefore relatively simple), but also because the implication of litigation-type action at the formation of an agreement would be considered hostile and not grounds for a fruitful business relationship. In addition, many lawyers have observed that less sophisticated Ghanaians would not chose arbitration for other reasons. First, many entrepreneurs do not believe the arbitral award is enforceable, meaning they doubt the effectiveness of arbitration. This, the lawyers say, is purely a misperception, as arbitral awards under this act are enforceable in the same manner as a judgment or order of the court. 46 Second, many doubt the objectivity of arbiters, fearing that the other party may have won their favor through bribes, sympathy, or possibly a common relative. While this concern may be justified in certain instances, it may often be a prejudice. In the event the arbiters fail 44 While side payments to court staff and/or judges are known to accelerate the process, it was difficult to determine to what extent this occurred. Additionally, it is important to point out that, in the observation of some, many Ghanaians don't value legal services, meaning they neglect to pay their lawyer's fees, which results in the lawyer's reduced services, which prolongs litigation. 43 An attempt was made a few years ago to institute some kind of clerk system, but this failed, apparently because judges did not want to delegate research and opinion drafting to clerks .. Although judges are overtaxed in this system, it does not seem to affect the quality of their opinions; promotion depends on the frequency with which one's opinions are overturned. Thus, judges seeking promotion are mindful of quality, judicially sound opinions. 46 Article 29.  82 to be impartial, the Arbitration Act allows for the court to remove partial arbiters·11 and to set aside awards that were improperly granted. 48 Given the infrequency with which formal arbitration is used, it is difficult to say how long and costly such an appeal is. However, appeals in Ghana generally are known to be shorter than first instance hearings, as the written record of the original hearing (which contains all the pertinent facts of the case and reasoning of the decision) is already available (which cuts down the bulk of hearing time). Arbitration does have one major drawback; one must go to court to compel compliance with an arbitral award, thereby defeating the marginal gains won by arbitration. Again, because arbitration is seldom used, it is difficult to say how long an enforcement hearing takes. However, it would be relatively easy to devise an expedited hearing procedure for this purpose, especially since matters of substance would not be scrutinized. In addition, formal arbitration does impose costs on both parties, in terms of time, arbiters' fees, and lawyers' fees. Despite the aforementioned costs, formal arbitration could be a valuable alternative to the formal court system, particularly in terms of time and cost. One lawyer claimed to have conducted an arbitration lasting one month. Of course, such success requires the cooperation of individuals, which presupposes their faith in the method and an understanding of the time-value of money. This could evolve with increased use over time. Thus, a program to introduce Ghanaian commercial actors, both potential users of arbitration and arbiters themselves, to this form of disupte resolution should be given serious consideration. Informal enforcement mechanisms In light of the costs of formal adjudication, informal enforcement of contracts is commonly sought. Settlement usually consists of a negotiated payment plan. Informal enforcement takes a variety of forms, which will each be discussed below: informal arbitration, police intervention, and the use of paramilitary organizations. Inrormal arbitration. The most common and socially acceptable enforcement mechanism is informal arbitration. Informal arbitration resembles formal arbitration in many ways. Parties submit their dispute to a third party, who agrees to hear both sides and take a decision. Unlike formal arbitration, the involvement of a third party is not negotiated in advance; in fact it cannot be said to be negotiated at all, in that the third party is usually approached by the aggrieved party independently. The arbiter need not be trained in law or familiar with business practices, but tends to be an influential individual in the community, for example, a chief, an elder, or a prominent businessman. This kind of arbitration tends to be successful, i.e. the decision is accepted and complied with by both parties. In fact, many disputes over large sums are settled by informal arbitration. 47 Article 27. 48 Article 26.  83 Like formal arbitration, informal arbitration has probative value in court and is apparently enforceable by law. 49 Bringing in formality, however, is rarely necessary, not only because costs of formality are to be avoided, but also because usually the arbiter's moral and social authority over the debtor ensures the debtor would honor his obligation. The extent to which the arbiter's objectivity is ever corrupted by bribes or personal dedication to one party remains unclear; however, due to the frequency of using informal arbitration, so one may assume the system is satisfactory. The police and paramilitary organizations. Instead of seeking the guidance of a respected community, aggrieved parties sometimes hire local policemen or the so-called Ghanaian Revolutionary Organs,~1 which are paramilitary organizations that use force and intimidation to collect debts owed. The invovlement of the police is more common and seen as less threatening, whereas the use of the Ghanaian Revolutionary Organs is considered by everyone to be the most degenerate mode of contract enforcement and is used only as a last resort. 52 While this might be the most expedient mode of debt collection for a party who is owed money, such a system does not foster a stable environment for economic actors. The system leads these enforcers to favor him who hired them and not to serve the interests of justice based on economic principles. The Ghanaian Revolutionary Organs are supposed to be phased out under the new Constitution, but it remains unclear whether or not they will merely assume another guise. Even if they are dissolved, such enforcement "thugs" will continue to exist as long as there is a demand. If the government chooses to eradicate its system of this practice, it could reduce the supply for this service, but this introduces the problem of enforceability. For example, the government could make such "freelance" activity punishable by expUlsion from the police force. s3 But parties who hire these groups will not report this misconduct because 1) they benefit from this service, and 2) they are accomplices. Parties harassed by these groups won't report this misconduct out of fear. Thus, a better method of controlling this behavior is by reducing demand by offering a feasible alternative to potential users of this informal mechanism. 49 We learned this from one source only, who was reliable. Further research would verify this observation. so While this did not come out in the case studies, numerous lawyers told us that this mode of dispute resolution is quite common. In fact, it is possible that many firms' negotiation of disputes resembled informal arbitration. 51 Examples of these include the CDR (Community Defense Revolution), the COO (Civil Defense Organization) and the Militia. $2 In fact, it is likely that they are used less in commercial contract disputes than in cases of informal lending. In other words, those who are not in the business of lending money, and therefore have no intention or need to maintain a business relationship, will be most likely to employ these individuals. 53 While this activity is probably already illegal on paper, the law is apparently not being enforced.  IV. CONCLUSIONS AND POLICY IMPLICATIONS The main conclusions and policy implications derived from our findings and analyses are organized in four sections. Although the focus of these case studies of enterprise finance in Ghana was informal finance and especially trade credit, the findings suggest a number of policy implications in the realm of formal finance. These implications are briefly outlined first. Secondly, we present the implications derived from the analysis of informal finance, highlighting the findings that contest stylized facts commonly associated with informal finance in Africa. Next, we focus on significant policy implications emerging from the analysis of trade credit. A substantially unexplored and unexploited area of market-based policy intervention is uncovered by the linkages found between firms of different sizes and sectors. Finally, we summarize the possible interventions in the areas of contracting and contract enforcement suggested by the analyses of the legal system and conflict resolution. A. The Formal Financial Sector and the Incentives Problem The analysis of debt portfolios presented in Chapter II established not only the inefficacy of long- standing lending programs targeted to small enterprises through formal banking institutions, but also suggested the futility of targeting credit to small firms when large firms may be precisely the best conduit to increase liquidity among medium and small-scale firms through trade-credit linkages. As discussed in this report, the banks' general reluctance to lend is explained primarily by the incentive structure banks face, where attractive and secure government bonds and money market "investments" favorably compete with firms of unclear credit worthiness. These factors preclude the direct access to bank funding for these enterprises, and in addition constrain the availability of bank funds for well-established, fully secured, large firms which could otherwise perform the role of intermediaries in connection with their regular commercial activities. Thus a drastic change in the incentive structure surrounding formal financial institutions is called for, if lending to manufacture is to increase. The competition represented by treasury bills and the low- but-safe return offered by money-market transactions appears to be too strong for manufacture loan contracts which are costly to carry out and enforce. In addition, the discussion of the legal and regulatory framework for financial institutions and firms in Ghana highlighted the constraints on access to formal credit imposed by the current system of land ownership and transfer regulations, and the disincentives these regulations entail for banks to engage in private sector lending. Furthermore, the preference of banks for fixed property as loan security, along with their reluctance to take accounts receivable as collateral revealed a basic inconsistency between what manufacturing enterprises are in a position to offer vis a vis what banks regard as acceptable collateral. The risks and costs banks perceive in granting loans secured with collateral other than fixed property explains in part this contradiction. Reducing bank transaction costs of lending would constitute a step in the right direction, although not removing the main disincentive to lend to the private sector represented by the attractive returns associated with lending to the government. The initiatives some private sector institutions are exploring in the area of information systems, data bases, and credit reporting agencies offer potential economies in information gathering, loan evaluation and risk analysis that banks would certainly benefit from. If the safe haven of the Treasury were to disappear or reduce its significance, financial institutions are likely  85 to generate a strong demand for services that reduce their costs of lending and thus improve their expected profit margins. B. Strengthening Informal Finance Informal credit clearly appears to play an important role in the financing of small and medium enterprises in Ghana's manufacturing sector. These enterprises place significant reliance on informal finance for both start-up capital as well as incremental investments, although own savings for the former and retained earnings for the latter playa far more dominant role as source of funds. There is also evidence that firms use informal loans on a short-term basis for liquidity management possibly related to working-capital requirements. However, despite its quantitative importance, the informal financial sector in Ghana does not seem as institutionalized and commercialized as has been documented in case of some other countries, particularly in Asia. With one exception, no firm in the sample used moneylenders or any other intermediaries while the role of informal savings groups and collectors - susus - was also minimal. The vast majority of observed informal credit transactions are among close knit groups of family and friends, at no interest costs, and with fairly flexible arrangements in terms of repayment schedules and duration. The findings from this study have several important implications for policy and analysis. For example, much of the theoretical analysis of informal credit in developing economies blithely imposes various types of informational asymmetries among participants, a framework that may not obviously be appropriate for Ghana. Similarly, it is considered a stylized fact that informal credit is more expensive than formal loans, but the data in Ghana do not bear that out, at least in terms of the nominal interest rates (there may be other implicit costs). Probabl y, the most significant findings relevant to policy decisions relate to the observed underdevelopment of informal financial markets. Absence of such markets is remarkable given the high incidence of informal finance in Ghana and the pervasiveness of such informal financial markets in developing countries. Although efforts to enhance access of small and medium firms to formal finance are being undertaken, the majority of such firms are likely to continue extensive reliance on informal credit arrangements in the foreseeable future. Consequently, a major policy objective should be to faciJitate the development of informal financial markets in Ghana. Although the government or donor agencies do not have any direct mechanisms towards this Objective, the findings in this study suggest some possible interventions and caution against some others. Specifically, with respect to the latter, if the absence of informal credit markets suggests structural impediments, i.e., costs of transaction high enough to prevent the markets from being organized, interventions aimed at increasing availability of loanable funds in the market may not be productive. In Ghana, the findings suggest, it is not just banks that are precluded from lending to small and medium firms, because of high transaction costs, but also, in principle, the informal intermediaries. Positive interventions, on the other hand, would aim to reduce the transaction costs, enabling private individuals to organize market-based arrangements. Although conjectural, one possible impediment to informal intermediation may be related to problems of enforcement, manifested in the high incidence of respondents indicating inability to collect debts. Although some respondents in the January survey took evident pride in having a reputation of reliability in their financial transactions, delays in repayments are frequent, as noted for trade credit transactions, and the most common response to such  86 situations is patient hope on part of the creditor. 1 Some of this may indicate informal insurance or cooperative rjsk~sharing arrangements: for example, the most common cause identified by respondents for delayed payments by their debtors (for trade credit) was financial difficulties of the other person. This was used to explain why the response of the creditor was one of patient reminders. However, there were others who conceivably would have preferred to collect the payments but were unable to do so. To the extent lack of enforcement is not driven by risk-sharing reasons, improvement in enforcement through, for example, effective use of post~ated checks may be desirable. Establishment of small-claims courts, or enhanced priority within existing system to commercial cases involving post~ated checks, as was done in Taiwan successfully, may be one possibility. This implication is explored further later in this chapter. Another policy measure that can be used by the government and donor agencies to foster development of informal credit markets is through encouraging existing business associations to "make" markets. Business associations and associations of firms in fixed~site markets often do make informal markets, in the sense of regulating and enforcing consensual norms for credit transactions, in other countries. Many such associations already exist in Ghana and are actively used for, inter alia, conflict resolution by members. These may provide natural fora for forming and regulating informal credit transactions among members. Finally. in the same vein, the government and donor agencies can also encourage banks or non-bank financial intermediaries, including finance companies, to start small rotating savings and credit associations catering specifically to business individuals and operated on bidding systems. Such groups exist currently but are confined mostly to petty traders and allocate financial savings by rotation rather than competitive bidding. In principle, there is no reason why banks cannot organize such activities: they are profitable, they lead to considerable exchange of information about the firms and owners (an important constraint for bank lending to small and medium firms) and banks may better deal with the problem of credibility and enforcement than small individuals. C. Enterprise Financing through Trade Credit This study has demonstrated that in the manufacturing sector in Ghana trade credit was by far the most important source of credit for small firms. Accounts payable to other firms amounted to some 75% of all outside finance of firms with ten or fewer employees, while bank loans and overdrafts accounted for about 10% of all outside finance of small firms. Among medium-sized and large firms, by contrast, bank loans and overdrafts were by far the most important source of funds, contributing 76% and 82 % of all outside finance for medium and large firms respectively. Hitherto one of the common forms of intervention in the manufacturing sector has been the provision of loans, often at low rates of interest and targeted at small firms. It is widely accepted that most of these programs have not succeeded in their aim of providing finance for small firms, and have typically ended up granting loans to firms of medium and large size. I In contrast, commercial informal credit transactions in Asia are characterized by immense institutional pressures for punctual loan repayments; delays can be quite expensive in terms of market reputation. See, for example, the discussion of "hsin-yung" in Taiwan (Biggs(1988». Similar findings are reported for India by Timberg and Aiyar(1979) and Srivastava(1992).  87 Our dramatic finding regarding the importance of trade credit among small manufacturing firms suggests a new arena for public policy. Small firms are already succeeding in satisfying a considerable part of their credit demand by means of trade credit. Hence, it is likely that appropriate forms of intervention could strengthen their access to trade credit and in so doing serve them better than by attempting to provide them with formal sector finance through the banking system. Indeed, it is ironic that the trade credit area has been virtually neglected despite its importance among small firms in both developed and less-developed countries. A major policy intervention suggested by the findings concerns the concept of the trade credit multiplier, or the linkage between formal banking sector finance to large firms and trade credit to small firms. This idea is developed further below. This report has presented the argument that manufacturing firms in Ghana which possessed significant liquidity arising from loans were less likely to require advance payments and were more likely to sell their products on credit. The sample size was in no way sufficient to provide econometric proof, but using the case study approach and considering in detail the financial and production situation of both supplying firms and client firms, a good deal of evidence was presented that bank loans were on-lent to client firms in the form of trade credit, provided certain conditions were fulfilled. Among these conditions were the following. First, the supplier firm had to be faced with competition so that it had an incentive to provide trade credit in order to move its goods. It appeared that firms in monopoly situations had no difficulty marketing their products and therefore sold their goods by advance payment or for cash. Second, the product had to bulk sufficiently large in the requirements of clients that it was worth while forming a long-term relationship. Trade credit arrangements were found, for example, with cloth purchases by clothing manufacturers, because these purchases were large and regular. Trade credit arrangements were not found with purchases of thread, buttons and zippers, because these were smaller items which did not have to be purchased on a regular monthly basis. Third, the supplier firm and the client firm had to have a relationship of considerable standing. In many cases, small firms obtained trade credit from their suppliers only after buying from them on a cash basis for several years. Small firms which had recently started business were usually required to pay in advance or buy on a cash basis. Provided these three conditions were fulfiJIed, loans from the banking sector were likely to be translated into trade credit for clients, hence the concept of the trade credit multiplier, which connotes a ripple effect throughout the economy and in particular in the small-firm sector following an infusion of capital in the large-firm sector. With the data in hand we were not able to provide an estimate of the size of the trade credit multiplier. For this a substantially larger data set would be required. Indeed we would consider the creation of such a data set a matter of urgent priority. If further research demonstrates that the trade credit multiplier is large, there will be more justification for loan programs sponsored by the government and by international agencies. Targeting loan programs directly to small firms has largely proven a failure. Typically, those programs operating through public financial institutions result in outright, costly income transfers, primarily to the unintended population. On the other hand, programs that attempt to use the private banks tend to suffer from limited and sluggish disbursement to the target group. The common allegation explaining this limited success is that small firms do not meet the collateral requirements established by banks. However, it may be that some of the benefits of loans to firms which do possess the necessary collateral are passed on to small manufacturing concerns by means of trade credit.  88 The question arises whether it would be possible to engage in a limited form of targeting so as to exploit the trade credit multiplier. If one of the objectives of a loan program is to strengthen the fmandal situation of small firms, it would be of less value to provide loans to monopolistic firms which might not provide any trade credit. Similarly the provision of loans to firms in certain subsectors would be of little assistance to small firms; for instance, loans to firms selling thread and zippers would be unlikely to generate benefits for small firms because typically no long-term trade credit relations exist in this subsector. It is beyond the scope of this report to recommend any specific criteria to incorporate in the design of financial market interventions that exploit the trade-credit connection. Some suggestions may nevertheless be made. The discussion above suggests that a relatively mild targeting criteria would take into account the market structure of the industries in question, and the knowledge acquired during the program preparation about the prevalence of trade credit in the enterprise sector being considered for intervention. The policies and programs would then focus on those sectors where trade credit is extensive or where it offers significant growth potential. In other words, targeting would operate by proxy, as opposed to the design of complicated credit manuals. The temptation to design targeting requirements that involve "certifying" existing or alleged trade- credit connections with small firms should be resisted. Instead, policies should create the adequate incentives for trade-credit connections to develop and strengthen, while finance is expanded "at the top". Increased access to finance by the private sector at large, the elimination of credit allocation policies that limit businesses in their access to funds, and the introduction of modern financial technology should be the essential ingredients of policy interventions aimed at exploiting the trade credit multiplier. D. Contracting and Credit Rating A number of implications from the analysis of the legal system and contracts point towards interventions and policy changes that would improve the contracting environment for enterprises in Ghana. Two recommendations for improvements in the formal system are briefly outlined first. Then the idea of establishing credit rating agencies is presented as another promising area of intervention. Speed formal adjudication procedures Formal adjudication would be greatly accelerated if courts were supplied with stenograph machines. This could reduce court time by 6-8 months (see "The formal court system," above), thereby producing great savings in the commercial sectors. Additionally, it would increase the skills level of courts' administrative staff. &tablishing a system of small claims courts The current court system in Ghana, although not particularly expensive nor inefficient, nevertheless remains too costly for most commercial cases. The value of commercial transactions rarely justifies the cost and time involved in a legal suit in front of Ghana's regular court system. Setting up  89 a small claims court, however, may reduce the cost of legal proceedings and help bring the court system closer to Ghanaian businesses. A small claims court system in Ghana could be tailored on the model of small claims courts in the United States: no lawyers, short delays, expeditious procedures, and fast judgement. In the interest of fairness, decisions by small claims courts could be appealed in front of upper courts, at the election of the losing party. Credit Rating Agencies Another area of possible intervention is credit checking, which would allow new and smaller firms to establish credit-worthiness more quickly than they now do. Currently it takes years of cash purchases for these firms to earn the privilege of buying on credit. A credit checking facility would provide to suppliers information on potential client's financial activities, which could result in establishing trade credit relationships more quickly, and with longer terms and higher ceilings. A minimalist proposal for a credit reporting and checking system would consist of collecting, sharing, and publishing information on bounced checks. These could be used as an indicator of a firm's inability to comply with payment terms. This system would be valuable in identifying a significant portion of unreliable trading partners, writers of bad checks; however, it would not identify trading partners who are unreliable in other ways. Given its limited application, it is unclear whether a minimal credit reporting system could support a market for this information. It is also unclear whether demand is large enough to justify the cost of establishing such a system. A more comprehensive proposal would encompass the full range of credit reporting and credit checking facilities. In advanced countries, credit checking agencies collect large amounts of financial information, which is purchased by firms to evaluate potential recipients of trade credit. The high fixed costs involved (computer hardware, data processing personnel, telephone lines to bank and other credit reporting agencies) are covered by the high consumer demand. Whether the much smaller poorer Ghanaian economy holds sufficient supply and demand for this kind of information to justify its costs must, then, be examined. This in turn raises the question: why is there not already a market in credit reporting and checking? Two main reasons for this are: (1) an inadequate legislative environment, and (2) a lack of adequate adaptation by institutions. The existing legislative environment is not conducing to the exchange of credit information. Companies fear that releasing information on themselves and their clients could be passed on to competitors. Until adequate protection for companies and individuals is inscribed in law, it is unlikely that enough information would be forthcoming to make the credit reporting and checking business profitable. Regarding institutional adaptation and development, existing institutions such as banks, firms, and individuals would have to alter their attitudes and behavior so as to take advantage of this service. More credit would have to be sought and given in order for the service to develop. These institutional changes would result in a more competitive credit market and greater concern for one's own credit rating at the firm level (i.e. the incentive to repay debts and to write good checks would increase). Credit rating agencies in advanced western economies use two major sources of financial information for their databases: credit card account records and records on housing mortgages. These provide reliable information on consumer debt and possibly small business debt as well. A Ghanaian  90 credit rating agency would not have this kind of information at its disposal, as credit cards do not exist, and personal mortgages on homes may be scarce. However, other, equally significant information may be obtained on Ghanaian firms, which could serve the agencies purpose of providing an accurate picture of the potential borrower's income and liabilities. For example, apart from that divulged by the firms themselves, this information could be obtained on existing overdrafts, existing loans, mortgages on commercial and industrial property, and possibly pending law suits and unfavorable judgements (especially for non-payment or non-delivery). Furthermore, it may be assumed that the self-selection implied by applicants to the rating service provides some kind of screening mechanism. If it is assumed that, as Ghana becomes richer, a credit reporting and checking industry will eventually be established, the question is whether a limited form of state intervention could accelerate the process of setting up the first credit checking agency and inducing the initial changes in behavior. It may be that a critical mass of transactions has to be reached before the industry could be self-supporting; the government could help reach this critical mass by providing some initial funding, awarded by competitive tender, to an institution that wished to create a credit checking agency. Alternatively, the government might not wish to incur any financial responsibility for fear that this would make the private sector dependent upon subsidies. It could instead concentrate on passing enabling legislation. A "Credit Reporting Act" would provide protection for individuals and for firms against all forms of abuse. The categories of information that could be stored in the information repositories would be defined; the categories of individuals and firms that could access the information could be identified. It is important to note, however, that information access could turn out to be a great disincentive if firms do not want tax authorities to share this access. Note also that it would be difficult to exclude government authorities from this information on two grounds: 1) it is hard to justify denying access to public information by the government, especially if they are willing to pay the market price for it, and 2) it is doubtful that the government would restrict its access to such information (especially income statements) voluntarily through legislation. In other words, credit rating agencies that are based on transparency of information may not work in countries whose economies are 40-50% underground. If this is indeed the case, then radical, deeper-reaching economic reforms are needed before such an agency would work in Ghana. Apart from these issues, however, Ghana has a recent history of governmental abuse of access to bank accounts; thus, fears that credit repositories could be ransacked for information on financial dealings may be justified. Legislation alone would not be sufficient to protect people from this abuse of power. 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World Bank, "Towards a dynamic investment response", Western Africa department, Industry and Energy Division, Report No. 8911-GH, confidential, 1990.  APPENDIX Responses to Contract Dispute Questionnaire Non-Delivery by Swpliers Non-delivery of goods or services ordered is an infrequent phenomenon, with only 14 firms out of 58 recalling an incident of this sort. Most of the local cases involved the non-delivery or partial delivery of lumber and other wood products. In other sectors, the failure of foreign firms to satisfy orders often was the major cause of non-delivery. Traders tend to face more such cases per year than do manufacturing firms. This is to be expected because the number of transactions into which traders enter tends to be larger than that of manufacturing firms. In half the cases, partial or total payment had been made before delivery, which means that respondents incurred direct losses because of non or partial delivery. In most of the cases, however, no payment had been made prior to delivery and the firm only had to suffer the inconvenience of a failed order. Firms facing frequent non-delivery minimize the impact on their production activities either by over-ordering, ordering early, building up inventories, or securing supplies from other sources. Manufacturing firms suffered less than traders from non-delivery of paid goods because those firms are less likely to pay in advance and more likely to receive supplier credit. The reason given for the failure to deliver varied between industries. In the wood and metal sectors, the major reasons for non-delivery were suppliers' difficulty in finding suitable lumber and metal sheets as well as their own financial problems. In other sectors, the inability to produce or find suitable inputs was the major reasons given. Suppliers to traders and customer firms mostly blamed their inability to deliver on their insufficient capacity, the need to satisfy other customers as well, or mistakes and oversights. In a couple of cases, non-delivery occurred following an unexpected increase in price or costs for the supplier. The actions taken by respondent firms varied depending on the circumstances. When no advance payment had been made, firms typically waited in the hope that the order would eventually be fulfilled. If that did not happen, they canceled their orders. In a few cases, the order was not canceled due to wishful hope that the contract would eventually be complied with after economic conditions had changed to the respondent's advantage. Whenever payment had already been made, firms typically complained and harassed their suppliers, sometimes successfully, sometimes not. In the two cases in which non- delivery was attributed to drastic changes in the opportunity costs of suppliers, the respondents agreed to renegotiate the contracts. Renegotiation was also the normal outcome in cases in which only a very small portion of the order had not been supplied; typically, firms agreed to carryover the unfulfilled portion of the contract into their next transaction.  97 Appendix Non-delivery by suppliers Panel firms only: Total Traders Manuf. Wood Metal Garment Food Numberlyear 1.56 3.49 0.96 4.14 0.13 0.02 0.38 No. of reported cases 14 3 11 5 2 1 2 How long ago (days) 74 25 87 127 55 90 16 Imports (%) 29% 33% 27% 0% 50% 100% 0% II From public firms (%) 7% 0% 9% 0% 0% 0% 50% Pre-payment (%) 43% 67% 36% 60% 0% 0% 0% Partial delivery (%) 29% 67% 18% 20% 0% 0% 0% Reasons given (%) Equipment breakdown/ 14% 0% 18% 0% 0% 100% 50% Inability to produce Inability to find inputs 9% 0% 36% 40% 50% 0% 50% Firm going out of bus. 21% 0% 27% 40% 50% 0% 0% Supplied to other buyers 7% 33% 0% 0% 0% 0% 0% Mistake or oversight 7% 33% 0% 0% 0% 0% 0% Transport hazard 7% 0% 9% 0% 0% 0% 0% Delay in paperwork 0% 0% 0% 0% 0% 0% 0% Major price increase 14% 33% 9% 20% 0% 0% 0% Supplier was delayed 0% 0% 0% 0% 0% 0% 0% ! I Action Taken (%1 Do nothing/wait 14% 0% 18% 0% 50% 0% 50% Demand performance 29% 33% 27% 40% 50% 0% 0% Renegotiate terms 29% 67% 18% 20% 0% 0% 0% Cancel order/ 29% 0% 36% 40% 0% 100% 50% Demand refund  98 Appendix Late Delivery by SUDPliers There are many more cases of late delivery than of non- or partial delivery. About half the firms reported having faced the problem in the past, and the frequency of cases reported was about five times higher. The wood and food sectors were among the most severely affected, but the average delay was comparatively short. Imports are again over-represented as a source of late delivery in the other sectors. In these cases, the average delay is much longer, from 6 to 15 weeks. In only one-third of the cases -- one-fourth for manufacturing firms alone - had the order been fully or partially pre-paid. Public firms are notable for late delivery, particularly to traders and firms in the food sector, but the delays involved are often very short. Late delivery was essentially attributed by most traders and many manufacturing firms to transportation hazards and the inability of suppliers to satisfy all the demand. Equipment breakdown and the supplier's own inability to secure essential inputs were next on the list and most frequently blamed for late delivery in the wood and metal sectors. In some cases, late delivery appears to have been the result of exceptional circumstances. But in other cases, late delivery is a customary feature of the relationship between the firm and (some ot) its suppliers. Discussions with respondents indicated that late delivery may be part of a deliberate strategy by certain firms, in particular public firms, but also certain private monopolies and monopolistically competitive firms. The rationale for this strategy is as follows. In the presence of frequent and unpredictable delays in production, suppliers are unable to guarantee delivery on a certain date without holding inventories of finished products. By lowering the price of their products, however, they are able to attract buyers willing to put up with late delivery. Suppliers then are compensated for a lower price by transfering the burden of production risk and therefore the cost of holding inventories onto the buyer. With sufficiently low prices, suppliers may even be able to induce eager customers to pay advances, thereby financing their working capital and reducing their own contractual risk. In the wood sector, most firms face problems securing adequate inputs. Competition with exports for good quality timber explains the difficulties of the domestic wood industry. Before trade liberalization, these tradable inputs were underpriced and implicitly subsidized as a result of the overvalued exchange rate. Trade liberalization and the devaluation of the cedi lead to an increase in the domestic price for timber. As a result, local wood industries now must rely on lower quality timber, either rejects from exporters or timber harvested by small operators with inferior equipment using seasonally impassable roads. Most firms reacted to late delivery simply by waiting or sending an occasional reminder. In many cases, late delivery is part of a deliberate strategy by suppliers to maintain a constant queue of clients. In these circumstances, reminding the supplier is mostly a waste of time. While traders usually prefer to wait and even, in a third of the cases, to cancel their order if the delay gets too long, manufacturing firms are much more likely to pursue their suppliers and insist on timely delivery. Manufacturing firms require inputs to operate, but traders often have alternative ways of using their liquidity and thus can afford to wait.  99 Appendix Late delivery by suppliers Panel firms only: Total Traders Manuf. Wood Metal Garment Food Number/year 7.28 6.70 7.44 17.14 1.98 0.02 16.28 No. of reported cases 28 6 22 7 6 1 6 Delay in days 19 8 22 7 41 100 10 Imports (%1 29% 33% 27% 0% 33% 100% 33% From public firms (%) 18% 33% 14% 0% 0% 0% 33% Pre-payment (%) 30% 50% 24% 33% 17% 0% 33% Reasons given (%) Equipment breakdownl 21% 17% 23% 0% 33% 100% 17% Inability to produce Could not find inputs 29% 33% 27% 43% 50% 0% 0% Firm going out of bus. 0% 0% 0% 0% 0% 0% 0% Supplied to other buyer 36% 33% 36% 43% 33% 0% 33% Mistake or oversight 0% 0% 0% 0% 0% 0% 0% Transport hazard 29% 50% 23% 14% 0% 0% 67% Delay in paperwork 7% 0% 9% 0% 0% 0% 17% Major price increase 0% 0% 0% 0% 0% 0% 0% i Supplier was delayed 4% 0% 5% 14% 0% 0% 0% Action taken (%) Do nothing/wait 4% 67% 50% 57% 50% 0% 33% Demand performance 50% 33% 55% 71% 33% 100% 50% Renegotiate terms 7% 0% 9% 0% 17% 0% 0% Cancel orderl 18% 33% 14% 14% 17% 0% 17% Demand refund  100 Appendix Most Recent Problem with Suppliers The most recent problem that respondent firms faced with suppliers was typically one of deficient quality and, less frequently, one of late delivery. Non-deJivery again appears as an infrequent phenomenon. Traders were more affected by deficient quality and manufacturers by late delivery, but sample sizes are too small to estimate the difference statistically. Manufacturing firms have problems mostly with traders, while traders have problems mostly with manufacturers, small and large. This is consistent with the role of some traders as intermediaries between manufacturing firms, and between domestic firms and foreign suppliers. Foreign firms again account for a significant number of litigious cases, mostly in the metal and textile sectors. Public firms and agencies are cited as problematic suppliers by the food industry. Only a very small proportion of problems occurs with suppliers who also are relatives of the respondent. Respondents very seldom limit their business to relatives and often declare to prefer non- family members as suppliers. Most problems occur with long time partners, simply because most transactions are undertaken with long time partners. Furthermore, transactions with casual partners are more likely to be "cash-and-carry." Transactions that involve the kind of delayed obligations that make it possible for breach of contract to occur are more likely to be with long time partners. In three-fourth of the cases, direct bargaining with suppliers is used to solve the problem. This is true for traders and manufacturers across sectors. In the rest of the cases, the problems mostly resolve themselves. In the overwhelming majority of the cases, the problem is settled to the satisfaction of the respondent and business continues with the supplier. Possible exceptions are cases involving distant foreign firms who have failed to supply or have delivered grossly inadequate products. Firms dealing with chronically late suppliers constitute a special case. They rarely find it useful to pester their suppliers and often choose to wait with resignation. Eventually, the supplies are delivered to the relief of the respondent and a new order is placed. But the entire situation could hardly be described as satisfactory. Late and erratic deliveries place a strain on the receiving firm, forcing it to build up inventories or wait in line at the factory gate. They may also delay the firm's production and damage its reputation vis-a-vis its own customers.  101 Appendix Most recent problem with suppliers Panel firms only: Total Traders Manuf. Wood Metal Garment Food No. of reported cases 39 10 29 7 7 4 7 Type of problem (%) 8% 10% 7% 14% 0% 0% 14% Non-delivery Panial delivery 3% 0% 3% 0% 0% 0% 0% Late delivery 38% 30% 41% 43% 71% 0% 29% Poor quality 51% 60% 48% 43% 29% 100% 57% Supplier category (%t 1 0% 0% 0% 0% 0% 0% 0% 2 10% 20% 7% 14% 0% 0% 14% 3 31% 60% 21% 14% 14% 25% 29% 4 10% 0% 14% 0% 0% 0% 29% 5 31% 0% 41% 71% 57% 50% 14% 6 18% 20% 17% 0% 29% 25% 14% family (%t 5% 0% 7% 14% 0% 0% 14% First transaction (%) 5% 0% 7% 14% 0% 25% 0% Length of bus. relation 6.09 4.11 6.83 2.58 5.40 2.75 8.93 Use of bargaining (%) 74% 80% 72% 86% 71% 75% 71% Disputes settled (%) 87% 90% 86% 86% 86% 75% 100% Satisfied wi outcome (%) 83% 90% 81% 86% 83% 75% 80% Resumed business (%) 92% 100% 90% 86% 100% 75% 100%  102 Appendix Avoidance of Problems with Suppliers Respondents were asked what strategies they follow to avoid problems with their suppliers. Multiple answers were allowed. The results generally conform with a no-nonsense attitude toward business. More than a third of all the respondents - and nearly half the manufacturing firms -- stated that the best way to avoid problems was to inspect goods at delivery or before payment. Traders were less likely to inspect goods than were manufacturers, possibly because inspection is costly when goods are delivered in bulk and the number of individual transactions is large. Several firms also mentioned third party inspection of goods -- in particular inspection of all Ghanaian imports by SGS as a useful protection against deficient qUality. A third of the respondents indicated that paying cash for goods delivered on the spot and making sure that mutual obligations regarding payment and delivery were clearly defined and understood (although not necessarily put in writing) were efficient methods to prevent problems as well. Two-fifth of the firms declared that the best way to avoid problems was to deal primarily with suppliers with whom they had satisfactory business relations in the past. The overwhelming majority of firms deal with a limited number of regular suppliers from whom most inputs are purchased, often on credit. Furthermore, the duration of such relationships is very long. Continuing business with reliable suppliers thus appears as the dominant way of preventing conflicts with suppliers. But dealing with long time partners is not a perfect insurance against the occurrence of contractual difficulties. Most cases of contractural difficulties occur with long time partners. Nevertheless, when difficulties arise, they are more easily resolved with long time partners. As a result, respondents also cited their willingness to show understanding when difficulties arise as a way of avoiding problems. What they had in mind was not a disregard for contractual obligations, but a desire to maintain a positive business relationship with firms who often are their major providers of credit and only possible sources of supply. In the case of traders, the desire to maintain good relations with suppliers was complemented by deliberate efforts to cultivate one's image and relations through personal visits and business lunches. All this should not be interpreted, however, as meaning that firms are de facto vertically integrated with their suppliers. Most firms maintain their independence by making sure that they have access to more than one supplier and typically order from three or four on a regular basis. In some instances, firms choose to concentrate on a single supplier, even if it means putting up with delays and deficient delivery, because that supplier charges a price below that of competitors. Similarly, the few firms that face monopolistic or monopolistically competitive suppliers have little choice but do their best to maintain good relations with them. But firms typically remain organically and contractually separate from their supplier. Only in a handful of special cases was vertical integration or long-term contracting used to mitigate problems of supplies. Possibly the most representative case was that of a cereals trader who used a large number of agents to collect grain from villages. Firms are most likely to face contractual problems when they deal with unknown suppliers. This immediately implies that new manufacturing firms and firms reorienting their activities toward new sectors and products are most vulnerable to problems with suppliers. Similarly, the chance of traders running into contractual problems is higher than that of manufacturers because success in commerce requires that one be able to take advantage of ever changing arbitrage opportunities and be willing to transact with unknown firms. Carefully inspecting goods at delivery and paying cash for goods delivered on the spot are simple but effective ways of minimizing problems with unknown suppliers. But they are hardly applicable to large scale transactions and make the conduct of everyday business unnecessarily unwieldy. As a result, the respondents have developed various methods by which they attempt to screen new potential suppliers. Three of these methods rely on information passively acquired by the respondent. The first consists in relying on the reputation of a supplier or on the brand name of the  103 Appendix products sold. This method was cited by one respondent out of ten, mostly in the textile and garment industry. The second consists in dealing with suppliers that one got to know personally as a result of non- business relations. Relatives, church mates, and neighbors enter in this category. Only a couple of respondents cited this approach as a useful way of avoiding problems with suppliers. The third consists of dealing with suppliers who were recommended by people the respondent knew and trusted. Again only a couple of respondents listed this approach. Only in the food sector are the latter two approaches well represented, possibly because of the small size of some of the interviewed firms. Hence, these methods for identifying suppliers may be more relevant for small enterprises in the informal and rural sectors. The screening of potential suppliers can also be organized in a systematic way. This approach was adopted by one sixth of the traders in the sample. They used various techniques to assess directly the reliability of potential suppliers -- credit check, inspection of their premises and formal process of accreditation. Avoidance of problems with suppliers Panel firms only: Total Traders Manuf. Wood Metal Garment Food Number of answers 53 13 40 7 9 10 8 Method chosen (%t 32% 31% 33% 14% 56% 20% 38% Specify terms thoroughly Inspect goods on delivery 38% 15% 45% 57% 56% 70% 25% or before payment Use 3rd party inspection 8% 8% 8% 0% 11 % 10% 13% Buy from reliable sellers 34% 23% 38% 71% 22% 20% 50% Buy from non-business 4% 8% 3% 0% 0% 0% 13% acquaintances Use recommended sellers 4% 0% 5% 0% 0% 0% 25% Buy from reputed sellers 11% 15% 10% 0% 0% 30% 13% Rely on accredited firms 6% 15% 3% 14% 0% 0% 0% Cash-on-delivery only 36% 31% 38% 43% 33% 50% 50% Sympathize with 25% 31% 23% 43% 33% 0% 25% difficulties Cultivate good relations 11% 23% 8% 14% 11 % 0% 0% Vertically integrate 9% 8% 10% 14% 0% 0% 0% Other 4% 8% 3% 0% 0% 0% 13%  104 Appendix Non-Payment by Client Non-payment by clients is a more common phenomenon than non-delivery by suppliers, particularly if one only considers cases in which suppliers were paid but failed to deliver a substantial portion of the order. Non-payment becomes a more acute problem the closer one gets to the final consumer. Downstream firms, traders, and manufacturing firms dealing directly with customers like tailors were much more heavily affected than firms dealing mostly with other firms or traders. Among the manufacturing firms in the sample, non-payment was more prevalent among textile and garment firms, a possible reflection of the economic difficulties that the industry has had to face as a result of structural adjustment and trade liberalization. Discussions with respondents showed that exports are even more problematic. First, while 27 percent of the interviewed firms did some of their own importing, only 8 percent of them tried to export. Those who did try to export, however, invariably ran into problems. Some respondents cited the absence of SGS-like inspection as a way for foreign clients to reject goods after delivery and extort discounts from Ghanaian exporters. Exports to neighboring African countries also proved a source of problems. Trade across African borders is often informal in character. As a result, little protection can be expected from the law in either exporting or importing countries and contracts are hard to enforce. Alternatively, if one tries to follow legal procedures, the extra cost of paying all the taxes and getting all the required stamps jeopardize the profitability of the trade and consequently makes payment to the Ghanaian exporter less likely. Either way, inter-African trade appears as a very risky proposition to most manufacturers, in spite of ECOWAS and the overvaluation of the CFA Franc relative to the cedi. In most cases, non-payment occurred after delivery had taken place. Exceptions are cases in which customers failed to pick up their order. Bounced checks were cited only in very few cases. Non- payment was a problem only in transactions in which the client was granted credit by the respondent. In a number of cases respondents were "conned" by customers into letting them take the goods before collecting full payment. Typically, the goods were taken by the client on the promise of very prompt payment. The circumstances of each case varied, but the result was the same: respondents were reluctantly, but somewhat knowingly, dragged into a situation of extending credit to their customers. In half the cases, however, partial or advance payment was made so that the loss to the respondent was limited to part of the value of the sale. Reasons for non-payment fall into two broad categories -- upstream transfer of risk, and cheating. Half the respondents indicated financial difficulties of clients as the major reason for non-payment. In one case out of five, respondents specifically stated that clients had been unable to sell the goods supplied by or made from goods supplied by the respondent or that they had been unable to collect payment on such goods. Clients thus had passed commercial risk onto the respondent. In a third of the cases, respondents blamed dishonesty as the reason for non-payment. Traders and manufacturers in the wood sector are particularly vulnerable to -- or resentful of -- their clients' cheating. Other spurious reasons for non- payment, such as "the client had to travel", "the client moved" or "the client left that line of business" were also advanced by respondents, often with strong suspicion of dishonesty. The most likely course of action undertaken by respondents, particularly traders, when faced with non-payment is to harass the recalcitrant client and insist on fulfilment of the contract. Letters are sent, repeated visits are made to the work place or the home, insults are exchanged between respondent and client, screams are heard, and third parties and messengers are involved. In some of cases, the respondents agree to renegotiate the contract, for instance by allowing a payment in installments, but the border between voluntary rescheduling and coerced delay in collection is hard to draw precisely.  105 Appendix Respondents only seem to give up either when they have physically lost track of the recalcitrant client, i.e., when they no longer know how to find him or her, or when it has become clear that they are unable to force the client to pay. The ability to impose repayment seems to depend both on the client's financial ability to repay and on his or her continued practice of business. Respondents are at a loss trying to recoup a debt from clients who have left their line of business, even if they hold other assets, like a home. One respondent declared that she got a judgement against a client debtor and was awarded the right to foreclose on his home but refrained because she did not what to throw old people out on the street. Respondents who either have collected a substantial advance or have not yet delivered the good constitute an important exception. They mostly wait for the client to show up. This strategy is not always effective, however, in spite of the fact that undelivered goods usually incorporate materials and inputs that belong to the client. Custom-made items are often hard to liquidate, and certain respondents are unsure about their right to resell the good even after a substantial delay in payment. But at least the firm enjoys the psychological satisfaction that the client has not run away with the fruits of their labor.  106 Appendix I Nonpayment by client Total Traders Manuf. Wood Metal Garment Food I Number/year 2.00 4.89 1.03 0.18 0.29 2.90 0.27 No. of reported cases 30 10 20 2 5 7 3' How long ago (days) 426 245 517 200 436 210 1533 Export (%, 7% 0% 10% 50% 0% 14% 0% By public firm (%, 7% 10% 5% 0% 0% 14% 0% After delivery (%, 87% 100% 80% 100% 80% 57% 100% Partial payment made (%) 47% 40% 50% 50% 80% 57% 33% By bounced check (%, 3% 0% 5% 0% 0% 0% 0% Reason given (%) Economic shock 7% 10% 5% 0% 20% 0% 0% Unable to sell goods 3% 10% 0% 0% 0% 0% 0% Unable to collect 17% 20% 15% 0% 0% 14% 33% payment Financial difficulties 13% 20% 10% 0% 0% 29% 0% Client traveling 7% 0% 10% 0% 40% 0% 0% Client moved 7% 0% 10% 0% 20% 14% 0% Client cheated 27% 40% 20% 50% 0% 14% 0% Mistake or oversight 0% 0% 0% 0% 0% 0% 0% No reason given 17% 0% 25% 0% 20% 29% 67% Challenged quality of 3% 0% 5% 50% 0% 0% 0% goods Action taken (%) Do nothing/wait 23% 0% 35% 0% 40% 57% 0% Demand performance 63% 90% 50% 50% 60% 14% 100% Renegotiate payment plan 13% 10% 15% 50% 0% 29% 0%  107 Appendix Late Payment by Client Late payment by clients is customary. Delays of a few days are so common that they are not even mentioned by respondents unless specifically prompted. Problems with late payment are again more frequent the closer the firm is to final consumers. The average payment delay ranges from 6 weeks for manufacturing firms up to 20 weeks for traders. Textile and garmentmanufacturers are particularly affected, again a possible reflection of the difficulties of that industry. Traders face many more cases of late payment than manufacturers, particularly those who deal with retailers or final consumers. Payment collection problems seem to be so prevalent that they alone could explain the existence of a large number of trade intermediaries at the retail level, each limited by the ability to bear repayment risk and to collect payments from customers. Late payment in export contracts is less problematic because of the mechanism of the letter of credit. Payment of an irrevocable letter of credit is automatic after presentation of transport documents. In the case of standard letters of credit, payment can only be delayed if the client challenges the quality of the good supplied. Banks, however, are notorious for delaying the transfer of international funds so as to benefit from the accruing interest. With public firms or agencies, late payment is the rule and few firms are paid less than a month after delivery. Except for custom tailoring where late pickup by clients is common, delivery virtually always precedes late payment. This means that late payment occurs when an element of credit has entered the transaction. This element of credit may be voluntary, or it may be forced on the respondent against his or her will. For instance, in one case out of five -- one out of four with traders -- late payment is associated with bounced checks. Late payment is overwhelmingly due to temporary financial difficulties experienced by clients. In one-fourth to one-fifth of the cases, these financial difficulties are specifically associated with the client's inability to sell goods supplied by or manufactured with goods supplied by the respondent. Again, late payment is a way of transferring commercial risk onto the shoulders of the supplier. It is as if the seller of a good were implicitly providing a warranty that it would resell well. Family events were also invoked by clients to excuse late payment, an excuse that was more likely to be accepted by traders than firms. Unlike the case of non-payment, deliberate cheating was very seldom cited as the reason for late payment. The client's travel or leaving the business were seldom mentioned either. Mistakes and oversights were cited in a few cases, however, particularly in connection with bounced checks. Whether these were genuine mistakes remains questionable, but the respondents readily accepted the explanation in exchange for prompt payment! The course of action most likely to be adopted by respondents was to harass clients and insist on prompt payment. A large proportion of the firms, particularly among traders, agreed to renegotiate a rescheduling of payments and let the unfortunate client pay in installments. In the garment and textile industry as well as in some of the metal firms, however, the most common course of action is for the respondent to wait for the client to show up with the payment. Many of these firms produce custom-made goods and hang onto their output until the customer comes to pick it up and pay.  108 Appendix Late payment by client Total Traders Manuf. Wood .. Garment Food Number/year 62 235 8 1 9 9 6 No. of reported cases 41 12 29 2 7 9 6 • Delay in days 72 139 45 55 31 36 38 Export (%) 2% 0% 3% 0% 0% 0% 0% By public firm (%) 10% 8% 10% 0% 25% 11% 0% After delivery (%) 90% 100% 87% 100% 88% 67% 100% Partial payment (%) 14% 17% 13% 50% 38% 0% 0% By bounced check (%) 19% 25% 17% 0% 13% 11 % 17% Reason given (%) Economic shock 10% 17% 7% 0% 0% 0% 33% Unable to sell goods 21% 25% 20% 0% 13% 22% 17% Unable to collect 2% 8% 0% 0% 0% 0% 0% payment Financial difficulties 38% 33% 40% 50% 63% 44% 17% Client traveling 7% 0% 10% 50% 0% 11 % 17% Client moved 0% 0% 0% 0% 0% 0% 0% Client cheated 2% 8% 0% 0% 0% 0% 0% Mistake or oversight 10% 8% 10% 0% 13% 0% 17% No reason given 7% 0% 10% 0% 13% 22% 0% Challenged quality of 2% 0% 3% 0% 0% 0% 0% goods Action taken (%) Do nothing/wait 21% 8% 27% 0% 25% 56% 0% Demand performance 38% 25% 43% 50% 63% 33% 50% Renegotiate payment plan 40% 67% 30% 50% 13% 11 % 50%  109 Appendix Most Recent Problem with Clients In the majority of the cases, the most recent problem respondent firms faced with a client was a late payment. Only in the garment industry was late or non-pickup a serious problem. In half the cases, the problem was with an individual consumer or a small firm and in a third of the cases with a trader -- often a small retailer or itinerant peddler. Late payment thus appears to be a major way in which microenterprises and final consumers finance their purchases. The problematic client never was a family member or relative, and in three-fourth of the cases it was not the first transaction with that particular client. Nor was it the last. In two-third of the cases -- more for manufacturing firms, less for traders -- the dispute was resolved satisfactorily and business resumed. Direct bargaining was the favored method of conflict resolution for most firms, except those that could afford to sit on the finished product waiting for the customer to show up. On average, the respondent firm had been doing business with the problematic client for over four years. Late payment thus appears to be a major source of credit -- and insurance -- for poor consumers and microenterprises starved for working capital. In that sense, late payment is the consequence of their strong need for credit. Discussions with respondents brought to light another dimension, however. Microenterprises and final consumers manage to get away with repeated late payment because they are structurally insolvent. There is very little legal power that a creditor can bring to bear on a debtor who has no asset to foreclose upon. All a creditor can do in these circumstances is to harass and repeatedly visit the insolvent debtor, not in the hope that he will eventually give up one of his assets to pay for what he owes, but in the expectation either that he will come into some money or be able to borrow from someone else. Harassment and repeated visits thus serve a dual purpose. They make the debtor want to find the money elsewhere, and they make it very likely that the respondent will be there when the debtor comes into some money. For that reason, visits are mostly made on payday or market day, or if the creditor is aware that the debtor collected on a contract with a customers. This strategy seems to work fairly well, judging by the fact that so many of these cases did not result in non-payment. But it imposes a serious debt collection burden on the firms. Some of those who deal mostly with public agencies, the worst payer of all, even have a full-time staff member entirely devoted to debt collection. The ability of a firm to collect debts appears as a critical aspect of success in business, possibly one of the most important. Firms who are unable to collect payment from their customers get starved of working capital and are unlikely to survive very long. Persistence in debt collection is thus essential. Given that difficult economic conditions faced by consumers and retailers are typically passed onto their creditors in the form of non- or late payment, firms must also be vigilant when they extend credit. Whenever a sector or branch of industrial activity suffers an economic setback, the firms who go bankrupt are likely to be those who continued granting credit to clients on the verge of collapse.  110 Appendix Most recent problem with clients Panel firms only: Total Traders Manuf. Wood Metal Garment Food No. of reported cases 44 12 32 4 8 9 6 Type of problem (%) Non-payment 16% 25% 13% 25% 13% 11 % 0% Late payment of delivered 77% 75% 78% 75% 88% 56% 100% item Late pickup or non-pickup 7% 0% 9% 0% 0% 33% 0% of custom order % client 1 25% 8% 31% 25% 38% 56% 17% 2 23% 42% 16% 25% 25% 0% 17% 3 7% 8% 6% 0% 0% 11 % 0% 4 7% 8% 6% 0% 13% 11 % 0% 5 32% 25% 34% 25% 25% 22% 67% 6 5% 0% 6% 25% 0% 0% 0% Relative 0% 0% 0% 0% 0% 0% 0% First transaction 27% 25% 28% 75% 38% 22% 0% Length of bus. relation. 4.13 2.11 4.84 0.13 1.86 10.39 3.33 II c ........ aining 82% 100% 75% 100% 75% 33% 100% Settled 63% 58% 66% 100% 63% 56% 100% Satisfied 69% 64% 71% 100% 71% 63% 83% Business 67% 50% 74% 100% 75% 57% 83%  111 Appendix Avoidance of Problems with Clients By far the most expedient way of avoiding problems with cl ients is, quite simply, to insist on cash payment upon delivery. Credit should be granted only to clients who have demonstrated in the past their ability and willingness to pay. These two fundamental, common sense principles account for most of the answers given by respondent firms. Because bad payers are generally either insolvent or public firms and agencies, relying on legal sanctions and institutions is not perceived as a practicaJ way of preventing problems. Many firms do keep simple records of transactions and ask their clients to sign invoices when they get credit. But these records seem to be used more to minimize discussion on the reality of the debt itself than to ensure payment through legal recourse. Asking for an advance payment was presented by some of the manufacturing firms -- but none of the traders -- as a way of committing customers and reducing problems. Some respondents argued that asking for a sizeable advance would make sure that the client could afford the good, thereby implying that some customers would be glad to increase their well-being but let their supplier worry about how to pay for it. Taking an advance also reduces the exposure of the creditor firm. One respondent, however, avoided advance payment because he feared the commitment that it implied. Being a tailor under pressure, he preferred to take no advances and be able to return the material in case the client complained that the order was not completed on time. Another respondent made a very worrisome comment about advances. He declared that, whenever he had collected a significant advance, he would not mind renegotiating the price after delivery if he could see that he had made a sufficient profit on the sale. Although it is hard to be sure, this attitude seems to have encouraged numerous clients not to complete payment. Whether this particular firm can survive long on such principles is unclear. Currently. however, the firm is being propped up by the respondent's mother and uncle and lives happily under a soft budget constraint! The respondentproduces excellent quality work and, as a result, the firm has been expanding rapidly. Firms take different attitudes after problems have arisen. Some firms, mostly manufacturers, argue that one should show flexibility and understanding when difficulties arise. Others, mostly traders, suspend credit to bad payers and insist on the settlement of old debt before granting new credit. One woman trader, however, explained clearly the dilemma facing a wholesaler whose retailer is not selling and who as a result is unable to pay. If the retailer is refused further credit and remains stuck with textiles that do not sell well, her business will go down and the wholesaler may never recover her money. If the retailer is given new, hot selling textiles, however, her business may regain impetus. In the process, the slow moving textiles may actually find buyers and the wholesaler may recoup her money. This is another illustration of the classical creditor's dilemma: gambling good money after bad may be the only way to get both back! One firm out of six -- one of three in the textile and garment industry -- mentions keeping customers satisfied as a way of avoiding problems. In some cases, threrefore problems with payment collection may be related to unsatisfactory output. Other respondents note that certain clients use the excuse of small defects to delay payment or to attempt to renegotiate prices. Producing quality output is thus a way of denying clients such excuses. The granting of credit only to clients who have paid in the past may work reasonably well on average. But how is one to identify such trustworthy customers? One way of finding new reliable clients  112 Appendix is to rely on personal recommendation by people one already trusts. If the person making the introduction is trustworthy, it is a signal that the introduced person may be trustworthy as well: birds of a feather flock together. But the person doing the introduction often provides a form of implicit guarantee as well. Although he or she may never be asked to pay the debts of the new client, the creditor is sure to pester him or her in case a problem would arise and to ask for intermediation. Furthermore, if the new client were to prove unreliable, the reputation of the recommender would become tainted as well. Most people would hesitate to endanger a long-standing business relationship and the line of trade credit attached to it just to please a casual friend. As a result, the process of personal recommendation is relatively safe. Non-business relations -- Le., relatives, neighbors, and church mates -- play little role in identifying trustworthy clients. Several respondents hinted that liberally selling on credit to relatives and neighbors would amount to signing the death warrant of the firm. Late payment and non-payment would be frequent as friendship and family ties get in the way of pressuring clients in financial difficulty. And if the relative or friend were not in financial difficulty to start with, granting liberal credit terms would get him there! Instead, people bring their relatives and friends to their suppliers and recommend them for credit or preferential treatment. Cases were also encountered whereby firms used the children of employees, friends, and neighbors as agents to sell their ice-cream. These itinerant retailers enjoy a good deal of independence in the way they operate, are fully responsible for their sales, and thus can be considered as 'clients' of these firms. But they are totally dependent on the firm for their equipment and supply and, in several cases, could not operate without the firms' short term credit. Again, neighbors and employees act as guarantor and means of pressurizing the boys if they misbehave. Reputation per se, as distinct from interpersonal relations, seems to play very little role in identifying reliable clients. There seems to be no mechanism whereby information about clients' trustworthiness is shared among firms other than direct recommendation by people one already knows. When prompted directly, most firms declared that they would never bother to warn another firm about a particular untrustworthy customer. As a matter of fact, one got the distinct impression that certain respondents relished the idea that their competitors may have to deal with the same crooks by whom they had been burnt. Sharing valuable information with competitors would provide them with an undue advantage, and no effort was made in that direction by most respondents. The only possible exception concerns Accra's women fishmongers, but their situation is somewhat peculiar. They all belong to a closely knit neighborhood, they share the same ethnic background, their husbands go out to sea on the same boats, and they all sell in the same market. These women greet bad payers on the market place with screams and shouts, and share information instantly in this simple but effective fashion. As a result, a bad client would find it difficult to remain in the fish retail business since she would cut herself from her major source of supply. A significant portion of the surveyed firms also uses more elaborate procedures to assess a client's credit worthiness. One-fourth of the traders and one-sixth of the manufacturing firms indicated that they take positive steps to assess the credit worthiness of prospective trade credit recipients. The simplest method consists of inspecting the client's work place. It is important to make sure that the client is what he or she claims to be. Granting credit to a genuine business may be a way of acquiring a new regular customer, but letting some hit and run speculator take goods without paying is calling for trouble. Simple inspection of the work place may also reveal whether goods are currently being produced and the client's business is prosperous. Similarly, if the client is a final consumer or an itinerant trader, checking his or her residence and spouse's work place provides information about that person's wealth and ability to pay.  113 Appendix More elaborate screening mechanisms can also be undertaken if one happens to have old friends among banks' staff. For a fee, one can have them run an informal credit check on one of their customers, thereby revealing useful (but confidential) information about the existence and magnitude of lines of credit, the frequency of bounced checks, and the regularity of deposits and withdrawals. The sale by bank staff of information regarding bank customers is illegal and must be done surreptitiously. Another elaborate screening mechanism, legal this time, is customer accreditation. In this process, prospective recipients of trade credit -- or more simply, people allowed to pay by check -- must provide information about their real and financial assets and possibly even put down a deposit. A more gradual approach to client assessment relies on learning progressively about a client's qualities and business performance through repeated sales. Rare are the respondents who answered that they would be willing to extend trade credit to first time buyers. As a matter of fact, only those few respondents who were able, thanks to special relations and lack of principles, to run detailed credit checks indicated that they were willing to do so if their investigation was satisfactory. But even repeated interaction is not a foolproof method for assessing a client's ability and willingness to pay. According to some game theoreticians, under repeated interaction compliance is best assured by building up a reputation of toughness. But acting tough was hardly ever mentioned by respondents as a way of avoiding problems with customers. Only one respondent insisted that he wished to maintain a reputation of toughness -- and that may have been more for the benefit of the interviewers than of the clients. Others indicated that they would negotiate firmly with bad payers. The reason why acting tough has no bite is quite simple: bad payers are typically insolvent, so there is very little one can act tough about - short of hiring thugs - an option that all firms find utterly disgraceful. But some do it anyway. In spite of all their sophistication, however, the above methods offer little protection against good payers who, due to unexpes:ted circumstances or from their own volition, become bad payers. There is the fish lady who goes out with a bang, buying large quantities on credit and then disappearing into thin air. There is the respected textile trader who retires, leaving large bills unpaid. There is the customer who dies, leaving behind debts that are disavowed by his heirs. There is the client who goes bankrupt, the client who moves to another city, and the client who decides to take on another business. In all these cases, a business relationship that was apparently going well suddenly turns sour, leaving behind unpaid bills. Although this is in a way a 'taboo' subject -- in the sense that it raises the respondents' worst fears and is not pleasant to discuss openly -- most of the cases of non-payment reported by respondents loosely belong to this category of good business relation turned sour. In all cases, respondents seem to have been caught unaware, which suggests that whatever monitoring mechanism they had put in place was easily fooled by their good-turned-mischievous client. Firms seem to expect some portion of their loans to be defaulted as a regular risk of doing business.  114 Appendix Avoidance of problems with clients Panel firms only: Total Traders Manuf. Wood Metal Garment Food Number of answers 53 13 40 6 9 11 8 Method(%) Clearly define contract 17% 15% 18% 50% 22% 9% 0% Cash-on-delivery 68% 85% 63% 83% 44% 64% 75% Insist on down payment 13% 0% 18% 17% 22% 27% 0% Hold client's property as 8% 0% 10% 0% 0% 36% 0% guarantee Show flexibility 25% 15% 28% 50% 33% 9% 38% Stop credit to bad payors 17% 38% 10% 17% 0% 0% 38% Keep customer satisfied 15% 8% 18% 17% 22% 36% 0% Sell to reliable buyers 47% 69% 40% 17% 67% 18% 50% Sen to non-business 6% 8% 5% 0% 0% 0% 25% acquaintances sen to recommended 23% 23% 23% 33% 33% 0% 38% buyers Sell to persons of good 9% 8% 10% 17% 0% 0% 13% reputation Screen clients 15% 23% 13% 17% 22% 0% 13% Assess client through 19% 15% 20% 0% 22% 27% 38% repeated interaction Insist on deposit, etc. 8% 15% 5% 0% 11 % 0% 13% Act tough 4% 8% 3% 0% 0% 0% 13%