working capital and export distance is shown empirically to be positive and significant, lending support for the working capital model of the firm’s export decision.

The paper is structured as follows: the next section discusses the relevant literature for both theoretical firm models and empirical work in the area of export and finance<sup>4</sup> , Section 3 motivates the need for the working capital model of export decision by taking a preliminary look at the data to examine the distribution of productivity between exporting and non-exporting firms and also to look at the additional working capital demands that exporting imposes, Section 4 develops the working capital model of the firm’s export decision, Section 5 examines the empirical results and then the conclusion.

# **2 Relevant Literature**

The role of firm productivity as a determining factor for the export status of the firm has been researched extensively both theoretically through the heterogeneous firm models of **??** and empirically in the work of **???** . It is, however, ambiguous as to whether the existence of financial constraints changes the relationship between productivity and exporting.

The literature on the interaction of trade and financial factors has existed for some time(see **?** ), but the emphasis has been on incorporating finance into the theory of comparative advantage to explain trade patterns across countries. Only more recently has the new trade literature begun to consider the role of finance in heterogeneous firm models (see **????** ). Existing models of exporting decisions such as **???** assume a set percentage of borrowing and do not account for the accumulation of internal finance that affect financial constraints and reduce the demand for borrowing. Their models assume that all firms are affected by financial constraints, due to the set borrowing requirement, and therefore financial constraints will _always_ influence exporting decisions, regardless of differences in internal financing between firms. This is a restrictive assumption as it is important to take into account both good financial health, when firms do not require to borrow, and when firms are financially constrained so as to accurately capture the impact of financial constraints on the distribution of firms in the aggregate.

Existing models also assume that allocation of credit is perfectly aligned to productivity. This assumption drives the result of these models: exports with financial constraints simply raises the productivity cutoff across all firms. Existing models assume no time difference between inputs and revenues and as such, the financing of the inputs responds directly to the input choice. This, coupled with the assumption that credit is perfectly aligned with productivity, drives the existing models’ result.<sup>5</sup> However, existing literature has shown that the allocation of credit does not correspond perfectly to productivity (see **??** ). The assumption of direct correspondence is thus too strong as it does not allow for the existence of distortions in the allocation of credit. The assumptions made by existing theoretical models, static borrowing demand and direct correspondence between allocation of credit and productivity, lead to essentially the same result as predicted by **?** with the caveat that financial distortion raises the productivity cut off level across all firms.

The empirical literature using micro level data on the relationship between exporting and finance is limited due to both the availability of firm level data sets as well as the topic being an emerging area of research. Of note, one of the few studies is **?** that uses a large UK panel data set. They show that the financial health of

> 4The literature on the area of trade credit , such as **?????** reviewed in **?** .

> 5The working capital model differs from the existing models in that the firm’s maximization problem at time _t_ is bounded by predetermined internal revenues- that is, revenue is a state variable. Even if credit is perfectly aligned to productivity in the working capital model, this would not detract from the predictions that are driven uniquely by the timing difference between inputs and receipt of revenues.

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