Financial constraints and the export decision of Pakistani firms

Abstract

The payment of sunk costs associated with the entry to foreign export markets highlights the significance of financial dimension in the firm decision. The sunk costs become a challenge for the financially constrained firms. In this paper, we study the relationship between financial constraints and the export entry decision of the firms in a lower-middle income country context. We use new measures of financial constraints in finance literature alongside widely used measures of financial health in trade literature to scrutinise the relationship for Pakistani listed manufacturing firms. We find that being less financially constrained is a vital determinant of the Pakistani firms' export participation decision irrespective the high firm leverage before entry. The undeveloped financial system and heavy reliance on bank loans for external finance in Pakistan may be the plausible explanations for our findings. Our results suggest that measures of financial constraints are more appropriate than the widely used measures of financial health in studying the determinants of the export participation decision. In addition, we find evidence that future exporters improve their financial conditions prior to entering the export markets. However, we do not find any evidence that exporting improves financial conditions of the firms after entry.