Towards Developing Trade Credit Policies in the Ghanaian Construction Industry: An Analysis of Constraints

Abstract

The excessively expensive and inaccessibility to bank finance by many contractors for financing the construction industry among other factors explains the underdeveloped nature of the construction industry in Ghana. Trade credits which have been recognized in extant literature as both a substitute and complement to bank financing is also experiencing a market failure; yet, little to nothing is known about the constraints faced by supplier in extending trade credits to their contractors. This may lead to a weak reliance on findings from other economies for policy trade credit formulation. Nonetheless, contradictions about the cost of trade credit compared with bank finance and its position in the pecking order indicate that country-specific evidence is imperative. By adopting the Relative Importance Index (RII) aided by Principal Component Analysis (PCA) in analysing data collected from 75 SME construction merchants within the Kumasi metropolis of Ghana, the study concludes that three interwoven principal components: (1) Asymmetric Information (2) Weak Legal Environment and (3) Weak Macroeconomic Variables are the constraints to trade credit supply in Ghana. Asymmetric information is characterised by poor accounting standards and little education on trade credit; while the difficulty in enforcing the terms of trade credit contracts expand creditors’ risk constituting a weak legal environment. The high cost of financing materials acquisition underscored by high interest rates prices-out many buyers, which disincentivises the offering of trade credit. Theoretically, three trade credit models including the Agency Model, Financial/Liquidity Theory and the Marketing Theory are applicable in explaining the low levels of trade credit financing in Ghana. Practically, the paper provides a basis for budding appropriate trade credit policies and market in Ghana. Future research could concentrate on developing a framework for trade credit contracts in Ghana as well as developing mechanisms to overcome information asymmetry. We could further look at assessing the potential role of trade credit in the development of the Ghanaian construction industry, and how the establishment of a construction industry regulatory agency could promote the development of trade credit options.

Keywords: Legal Environment, Trade Credit, Contract Enforcement, Constraints, Asymmetric Information.