Trade and Firm Financing

Abstract

This paper studies how financial frictions pose a barrier to export entry by altering the firm’s long-term capital structure, and thereby affecting the ability to finance sunk entry costs. Our focus on long-term firm financing stands in contrast with the emphasis in recent trade literature on the financing of short-term working capital as a barrier to export entry. We provide evidence that U.S. firms engaged in export tend to have leverage ratios higher than non-exporting firms in terms of long-term debt, but not in terms of short-term debt. To explain this fact and understand its implications, we marry a corporate finance model of capital structure, featuring an endogenous choice between equity and long-term debt financing, with a trade model featuring heterogeneous firms. The model of optimal capital structure indicates that in the long run, exporting firms will prioritize reducing the cost of long-term capital, used to pay sunk costs, over relaxing a short-term working capital constraint, which could be used to scale up production.