The Influence of ethnicity on the Provision of Trade Credit

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The Influence of ethnicity on the

Provision of Trade Credit

An empirical analysis of access to trade credit for the two

ethnic groups in Tanzania

Name: Hassan

A. Ibrahim

Student number: S.1660586

August 2007

UNIVERSITY OF GRONINGEN

Faculty of Management and Organization / Economics

MSc Finance

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The Influence of ethnicity on the

Provision of Trade Credit

An empirical analysis of access to trade credit for the two

ethnic groups in Tanzania

Abstract

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For a period of one year, I studied MSc Finance at the University of Groningen. For the last part of my study, I was researching on the Influence of ethnicity in Trade credit in Tanzania. The study was aimed at comparing two ethnic groups that are engaging aggressively in trade activities and to find out whether credit provision is connected with ethnicity.

During the process of undertaking my research, several people helped me to accomplish this thesis. First, I would like to thank the NUFFIC project for funding my studies. Secondly, I thank my mentor, Prof Bert Scholtens for his tireless advice on the subject and various comments.

Also, I would like to thank Dr M.J. Assad of the University of Dar es Salaam who gave me courage throughout my studies. I also thank my sister Aziza and my brother Hussein who provided me with the real life advice that ensured the thesis is accomplished on time.

Lastly but not the least, I would like to thank my fiancé Hamidah for her courage and comments during the whole time of my studies and my daughter Kauthar for accepting my absence during my studies.

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CHAPTER 1

INTRODUCTION

The preposition of scarce resources in relation with unlimited needs is widely known in economics. Although resources are scarce, financial resources like other resources are essential to boost business ventures. Firms are ever hunting for finance to carry out business operations but the degree of access to finance varies widely among business ventures depending on the level of risks of the borrowers and the existing social ties. Small and poor entrepreneurs make up a large proportion of the society but their access to finance has been critical due to the risk inherited in their business, (Fafchamps, 1996). The difficulty in access to finance is amplified in developing countries in which such access is facilitated by social ties, (Fisman, 2000). These difficulties of access to finance preclude expansion and innovation of business ventures because entrepreneurs cannot reach new market segments and innovate new products. If a large proportion of entrepreneurs are denied access to finance, it is obviously that the economy cannot attain its potential.

Various sources of finance are used as a means of finance to curb financing difficulties in order to reduce the impact in economy, (Shane, 2003). Recent studies show that trade credit is among the short term finance that has greatest contribution in backing firms to achieve objectives. Rajan et al (1997) in their sample of US firms explain that in average trade credit accounted for 4.4 percent of sales in small firms and 11.6 percent in large firms. This pattern can also bee noticed in other G71_{nations where accounts payables of}

large firms’ accounts for 17 percent of assets in France to 11.5 percent of assets in German, (Berlin, 2003). The significance of accounts payable has also been observed in developing countries. Berlin (2003) reveals that amount of accounts payable in developing countries are increasing. Consistently, Fafchamps (1996) finds that trade credit accounts for a quarter to a third of all outstanding balance in Zimbabwe.

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While trade credit is the largest short term source of financing, the literature has documented diverse motives for suppliers to offer trade credit, (Fisman, 2004; Biggs et al, 2002; Fisman, 2001). For instance, Fisman and love (2003) finds evidence that the provision trade credit in Sub Sahara Africa is aimed at retaining customers therefore it is used as a competition tool while Woodruff et al. (1999) argue that monopoly power is positively related to the provision of trade credit. Furthermore, they claim that the positive relationship between monopoly power and the provision of trade credit is facilitated by the ability of monopoly to cut off supplies in case a borrower defaults.

Explanations for the variations of motives of trade credit provision are supplemented with credit theories. For instance Pike et al. (2005) argue that the provision of trade credit are consistent with quality guarantee theory while Mian and Smith (1992) in their study of UK small firms find that credit provision were in line with financing advantage, price discrimination and transaction costs theories.

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In line with this argument, Leighley, (2002) claim that too often researchers compare behaviours of one minority group with that of majority population or assumes that the factors that influence the behaviour of the minority have the same bearings on another, unfortunately the approach do not allow for theory building on the comparative dynamics for minority. With that regard, in this study the Indians minority and one of the tribe, Chaggas2 in Tanzania which is prominent in business activities like Indians are compared to provide understanding whether the noted effect of ethnicity in the provision of trade credit has an explanation on minority effect.

Ethnicity in this context is limited to a social group formed as a result of sharing common values, (Eastman, 1975). For instance Chaggas in Tanzania are considered to be one ethnic group because of their activities, location where they are found, values, similar race with other ethnic groups found in Tanzania, accent and language they use while Indian-Tanzanians are considered as minority because of their skin colour, originality, language and their mode of interaction with the society. The difference of this study from the previous ones, Fisman (2001) and Fafchamps (1999) is based on the formation of the groups that are used in the analysis. Instead of analysing Tanzanians at large without taking into account the existence of sub-groups, the study compares access to trade credit between one ethnic group of Tanzanians (Chaggas) and Indians to find out whether ethnicity or minority has an influence on the provision of trade credit. The choice of Chaggas from several tribes of Tanzania is based on their ability to engage aggressively in trade activities in Tanzania, (Arens, 1973). Furthermore, Chaggas are considered to be

among East Africa’s wealthiest and most highly educated people and they are the people who are found even in obscured corners of Tanzania working as traders and merchants3. Whilst Indians are chosen to enable in-depth comparison with Chagga-Tanzanians since their pattern is known from previous works of Kenya and Zimbabwe, (Fafchamps, 1999; Biggs et al. 2002).In carrying out the study, the following hypotheses are examined;

2_{The tribe found in northern part of Tanzania occupying the southern and eastern slope of mountain}

Kilimanjaro

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1. There is a positive relationship between the provision for trade credit and one’s belongingness to an ethnic group.

2. There is no relationship between access to bank overdraft and belongingness to an ethnic group

3. Indian (minority) group has higher access to trade credit than Chaggas firms. It is obliviously that if resources are not allocated effectively and efficiently the economic cannot attain its potential. For that case, this study intends to find out the way resources are allocated among individuals and used as a means to create debate amongst academicians and other stakeholders on the proper allocation of resources.

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CHAPTER 2

THEORETICAL BACKGROUND

Various authors explain the importance of adequate financing. According to Carrol and Hannan (2000) adequate capital is important to the exploitation of opportunities that enable firms to survive, grow and become profitable through the provision of a buffer against adverse circumstances. This argument implies that having more capital overcomes liquidity constraints that limit the approaches entrepreneurs can take to pursue opportunities. This claim is in line with the argument of Baum (1996) who argues that capitalization influence external stakeholders perception of stability, legitimacy and dependability of ventures. Various means of finance are considered as the source of a firm’s capital. The sources are divided into external and internal financing. Commercial banks, building societies, factoring services, share issue and debentures are considered as external sources of financing while retained profit, sale of assets, reducing stocks and trade credit are considered as internal source of financing. However, in this study, the discussion is limited to only one form of financing namely trade credit.

Trade credit4 is an arrangement between a firm purchasing materials or supplies and its suppliers (creditors) whereby the supplier delivers the goods and then agrees to defer payment of the debt. It is an obligation that arises from ordinary business transactions and it considered as a natural way of obtaining short term finance. Normally trade credit appears as account receivable on the balance sheet of the suppliers while for the debtors, they are accounts payable. In discussing trade credit, this chapter discusses the roles and theories of trade credit, motives for the provision of trade credit and finalizes with the discussion about the relationships between trade credit and ethnicity.

The decision to offer credit in developing countries is normally surrounded with uncertainty regarding the ability of a borrower to pay the loan advanced. These uncertainties are built on information asymmetry, culture practices and insufficient legal

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enforcement, (Fafchamps, 1999). The root cause of these uncertainties is the difference of risks inherited in the entrepreneurs business, legal framework and credit worthiness of borrower. Therefore, in the risk environment issuing a credit need in depth scrutiny of the quality of the borrower before a decision to grant credit is implemented. However, with all uncertainties surrounding repayment of amounts advanced, lenders/suppliers have consistently continued to offer trade credit to their borrowers and debtors. Studies have indicated the increase in the use of trade credit, (Nilsen, 2002; Mian and Smith, 1992). In USA 13% of total liabilities in US manufacturing firms comprise of accounts payable, (Nilsen, 2002). Furthermore, Mian and Smith (1992) point out that for a sample of manufacturing firms in Compustat, 21% of assets were account receivables.

Various authors Fisman and Love (2003), Peterson and Rajan (1997), Summers and Wilson (2002) examine the motives behind the provision of trade credit and investigate their relationship with trade credit theories. However, the findings show that the relationship provided with trade credit theories vary from one study to another possibly because of differences in environmental settings and the availability of opportunities for the lenders and borrowers. To provide a clear picture for the diverse motives of offering suppliers’ credit, trade credit theories are discussed.

2.1 Trade Credit Theories

Previous studies have examined the provision of trade credit in different market structures, economic development and product characteristics and investigate their relationship with trade credit theories, (Fisman and Love 2003; Summer and Wilson, 2002; Lee et al 1993). Among the commonly known trade credit theories are;

2.1.1 Price discrimination theory

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price because of their difficulties in access to finance. But the credit terms that lead to higher price do not attract creditworthy customers because to them, the products are overpriced; therefore they tend to opt for prompt payment rather than delayed payment. On the other hand, risky customers find it is worthwhile to borrow through trade credit because to them trade credit is still cheaper than other sources which they can access trade credit, (Fisman and Love, 2003). This explanation is in line with the argument provided with Peterson and Rajan (1997) who argue that price discrimination is more appealing to firms with high profit edge because price discrimination allow customers of different risks category to access trade credit thus it is used as a means to boost sales.

2.1.2 Transaction costs theory

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2.1.2 The warrant for product quality

The warrant for product quality asserts that trade credit is used as the guarantee for product quality, (Peterson and Rajan, 1999). The theory claims that suppliers offer trade credit to provide assurance on the quality of product by giving buyers sufficient time to test the product before payment is effected. This argument is also presented by Lee et al. (1993) who find that credit terms are meant to implicate the quality of the product. This is done by specifying the number of days in which payment is to be effected and the discount attached there in. The discount attached is used as means of attracting customers for immediate payment. When the product quality is of wrong specifications from the one ordered by customers, customers are allowed to return the goods and they don’t have to pay for the products. Therefore, terms attached to credit can be useful in providing mechanisms to test the product quality and to provide an understanding of the quality of the product. Additionally, credit terms attached depend on the nature of goods whether goods are durable or otherwise. When goods are perishable, credit terms are expected to be short. Thus terms nature of the goods are used as a signal for the quality of the product which in turn facilitates the terms at which credit are to be provided, (Summers and Wilson, 2002).

2.1.3 The Customized product theory

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costs are more likely to allow credit for their customers to reduce the burden of sunk costs.

2.1.4 Financing advantage theory

This theory provides explanation related to the advantages of suppliers in provision of credit over the financial institution, (Fisman and Love, 2003). The theory point out three sources of costs advantages that favour supplies over monetary credit terms;

1. The first advantage underlies the benefit in information acquisition that a supplier has over the financial institutions. It is argued that suppliers are capable of getting superior information about the buyers by assessing the size of a buyer’s business and the frequency of buyer’s orders. If the size of the business decreases or purchases become infrequently, suppliers receive signal on the quality of a buyer which that is not the case with the financial institution. Financial institutions can as well obtain information regarding customers, however the costs and accuracy of gathering such information is not similar to the one obtained by suppliers because suppliers gather information during the normal course of business. Therefore, apart from getting accurate information, suppliers of credit in terms of goods obtain information at lower costs than financial institutions.

2. Another advantage literates the benefit that suppliers have in controlling buyers. This occurs if there are few economical alternative sources or no other means of financing than the supplier. If a buyer wants to take actions that might reduce the chances of repayment or changing the agreed mode of payments, supplier can threaten to cut off future supplies. This threat is more credible if a buyer accounts for only small portion of supplier’s sales and the buyer depends heavily on the supplier.

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Consistently, Mian and Smith (1992) claim that the more durable the goods supplied are, the better the collateral they provide and the greater the credit the supplier can provide and the higher the possibility of seizing them in case of default. It should be noted that it is also possible for the financial institutions to seize the goods but suppliers are more advantageous when they seize the goods because the selling networks they have established, reduce the possibility of reselling the products at lower costs.

2.1.5 The Impact of Specific Investment

Another theory that describes the rationale of the provision of trade credit is the impact of specific investment. Smith (1987) claims that if sellers anticipate bright future returns from a certain investment in their relationship with buyers, they are obliged to maintain it for economical benefits by providing credit to their buyers. In that respect, seller’s expectation on the future returns potential of a buyer gives a greater concern about the debtor than could not be the case with the financial institution.

2.1.6 The comparative advantage in liquidation theory

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2.1.7 Finance Motive Theory

Access to financial institutions and the differences between market borrowing and market lending rates of interests, allow suppliers to exploit the arbitrage. This leads to finance motive theory. Emery (1984) claims that more liquid firms extend more trade credit, also firms with higher costs of finance are not attracted to provide trade credit and may require prepayment to supply goods. For instance, smaller firms are subject to limited access to financial institutions thus they depend much on trade credit. In addition to this, Danielson and Scott (2004) study the relationship between bank loan availability and trade credit demand. They find that firms use much trade credit when faced with credit constraints imposed by the banks. Furthermore, they realize that trade credit offers more benefits relative to bank loans. The benefits include greater degree of financial flexibility of trade credit than bank loans, matching the timing of cash outlays for the cost of goods sold and receipts from sales. The impact of financial flexibility implies that when a buying/borrowing firm faces financial constraints, it is less costly to delay payment of payables (not pay within discount period, or net period) by the supplier than to renegotiate the terms of the loan by the bank.

Despite the explanations given on the theories, still the literature show opposing arguments on the mechanisms that enforce the provision of trade credit. For instance, Fisman and Raturi (2004) investigate credit provision in African countries and find that monopoly power is negatively associated with credit provision, and that the older the supplier-buyer relationship is, the stronger the correlation with the provision of credit. This finding contradicts the papers by Petersen and Rajan (1995) who argue that monopolists are more willing to provide trade credit because their customers cannot switch to an alternative supplier. To avoid contracting argument, it is worthwhile to provide explicit explanations on the motives for the provision of credit while linking them with trade credit theories.

2.2 Motives for Trade Credit Provision

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risks of shortage and quality of the products from the suppliers. However these risks do not restrict the parties in agreement to carry out their trading activities in the form of trade credit. A decision to carry out business in such risk environment means that there are some benefits and or reasons that enforce the provision of trade credits. In the next section, reasons and or motives underlie the provision of credit are discussed while linking them with theories to provide an understanding of why firms or individuals allow trade credits.

2.2.1 Market Motivation

The main reason for the suppliers to offer trade credit is founded on the market motivation argument. Summers and Wilson (2003) study the relationship between provision of trade credit and customers in UK based firms and find that extension of trade credit is intended to strengthen market relationship between buyers and sellers. Furthermore, they find that trade credit is used as a signal to send information to the market about the firm’s products and future prospects thus assist a firm to attain its market expectations. In general, they suggest that trade credit extension is considered to be customer focused thus it is a useful tool in increasing sales and business growth especially for firms with growth objectives. This motive is in line with the explanation of the price discrimination theory, the warrant for product quality and the customized product theories. By the use of trade credit, suppliers attain their market objectives as follows:

1. Retaining customers

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if a firm has managed to compete then it has managed to retain customers. Therefore trade credit is used as a tool to in retaining customers thus boosting sales.

2. Future negotiations

Suppliers use trade credit as a way of building market share by establishing long term relationship with their buyers which is vital in future negotiations. The relationship between buyer and supplier is achieved through provision of trade credit. When there is long term buyer-supplier relationship, buyers find hard to switch to a new supplier due to the switching costs that are associated with searching for a new supplier, establishing the relationship and the reliability of the new supplier. These difficulties show that provision of trade credit is important in building future negotiation which is essential for a firm to attain its market objective. This argument can be explained as follows; If a supplier is a monopoly or has been in credit relationship with a buyer for long time it is obviously that the supplier has a power over the buyer in negotiations since the buyer is familiar with the quality of supplier’s products and reliability of the supplier in meeting his demand. This explanation is supported with McMillan and Woodruff (1999) who find that monopoly power is positively related with credit provision. The positive relationship is facilitated with the negotiation capability that monopoly poses over the buyers. Apart from this monopolistic relationship, Summers and Wilson (2002) find that firms with lower profit margins extend trade credit to enhance their negotiation capability.

3 Long term relationship

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stronger with credit provision. In general, market motivation indicates that credit are provided as a means to retain customers, create long term relationships and to enhance negotiation capability of suppliers thus focus on achieving market objectives.

2.2.2 Product quality assurance

The second motive that triggers the provision of trade credit relates to the product quality assurance. In line with quality guarantee theory, Summers and Wilson (2002) claim that suppliers provide trade credit as a means to signal the quality of the product. This argument is based on their findings on smaller firms for which they claim that smaller firms with less public recognition are more likely to offer trade credit to enable customers to verify products quality. Verification of the product quality is achieved through allowing customers to delay payments. If customers are unsatisfied with product quality because of poor standard of the product or the product is of wrong specifications from the ordered ones, customers are allowed to return the goods without paying for them. This process of quality assurance which is considered as the resolution for buyers’ uncertainty regarding the product quality motivates suppliers to provide credit which is useful in increasing customers’ trust on the product quality which in turn assist a firm in boosting sales.

2.2.3 Economies of Scale

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motives, various authors5 point ethnicity as one of the factor that can be used to facilitate the provision of trade credit. With that regard, in the following section, the role of ethnicity in facilitating credit provision is discussed.

2.3 Trade Credit and ethnicity

While the discussion on the preceding pages shows the importance for entrepreneurs to obtain adequate capital to exploit opportunities, obtaining adequate capital has proved to be hard for entrepreneurs because of information asymmetry and uncertainty of the parties in the transaction. Information asymmetry is mostly associated with disclosure difficulties, opportunism and excessive risk taking while uncertainty is normally accompanied with inability to evaluate and need for collateral, (Shanne, 2003). Various studies have shown that firms in developing countries overcome the problem of information asymmetry and uncertainty by analysing information of their customers’ creditworthiness obtained from social gatherings, visiting business premises and from family members, (Murphy, 2002; Fafchamps, 1999). According to Mcmillan and Woodruff (1999), if a supplier meets frequently with a customer, there is a chance of about 20 percent points more for a supplier to grant credit to that particular customer. Consistently, Fafchamps (1999) finds that entrepreneurs who socialize with their suppliers are significantly offered more trade credit.

Studies in Kenya and Zimbabwe show that ethnic network play a role in access to firm’s capital, (Biggs et al. 2002; Fafchamps, 1998). Their findings are inline with various papers that argue that ethnic ties provide a great role of passing information and skills throughout the ethnic enclaves, (Borjas, 1992, 1994; Bertrand, et al., 2000). The explanation by Granovetter (1985) in the description of embeddedness of business relations provides additional support of role of ethnicity in the resources and information sharing. The claim is that when transactions take place within a tight-knit ethnic community, there is less scope for opportunistic behaviours, since such opportunistic behaviour can result in social sanction and exclusion from the ethnic business network. Essentially members of the ethnic group are able to share resources, information and in

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the end they may allow trade credit among themselves because of the trust created with ethnicity. In the presence of a tight-knit ethnic community, asymmetric information and opportunistic behaviours that might have precluded the cooperation between commercial enterprises are resolved with the ethnic network. The finding of Shanne, (2003) reveals that ethnic ties are important tool in over coming information asymmetry and uncertainty problem in financing because they provide four benefits to the suppliers;

1. If the supplier knows the borrower either through business activities or social network, the relationship between the parties reduces the likelihood for the borrower to act opportunistically towards the supplier. This is enhanced with the role of ethnic network of reducing the tendency of people to act in a self interested manner by infusing the relationship with the logic of social obligation, generosity, fairness and equity, Granovetter (1985). Ethnic network generates familiarity, the ability to predict the counter party behaviour and the ability to understand counter party characters. All these lead to trust and feelings of friendship between buyers and suppliers. Consistently, Cable and Shane (1997) find that information exchange is better when suppliers and borrowers know each other through ethnic network because ethnic network is useful tool in building trust.

2. Ethnic ties preserve ongoing relationships between a buyer and a supplier. Not only do people in an ongoing relationship have an incentive to preserve that relationship for future, but ethnic ties preserve a way to enforce implicit contracts through sanctioning mechanisms of ethnic networks. This sanctioning occurs when the suppliers/buyers communicate negatives about those who acted improperly, Granovetter, 1985). For instance supplier may communicate negatives about a buyer thus impound sanction on a buyer throughout the business network.

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of a firm especially small and new firm is not publicly available, ethnic networks provide a key mechanism for rapid transmission of information, (Uzzi 1999). Furthermore he argues that ethnic ties are useful in confirming the accuracy of information about an investment opportunity.

4. Ethnic ties increase the level of positive attributions made about others under uncertainty. Because people prefer to interact with other of similar social status and group, suppliers perceive ethnic interactions as the evidence of the quality of the entrepreneur and her judgments, (Glynn, 2001).

The basic idea underlying the role of ethnicity can be considered as follows: A supplier can provide goods on credit to a firm, the provision of that credit might have been stimulated with the motives that enforce credit provision to a supplier like reduction of transaction costs associated with the relationship with a buyer while for a buyer the motive can be to smooth production in the face of liquidity constraints. If the supplier has more ready access to capital, the decision to provide credit can increase the joint surplus of the two firms. However it also put the supplier to the risk of not being paid by the borrowers because of absence of mechanisms to enforce payments. In absence of legal enforcements, ethnic networks can used as a means to curb the gains from opportunistic behaviours by imposing sanctions to buyers who do not fulfill agreements. For that case, it is expected that higher rates of trade credit access should be observed within ethnic enclaves.

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argues that when there is minority with test of discrimination no entrants from other ethnic who can benefit by violating discriminatory customs. Furthermore, Granovetter (1985) claims that members of ethnic minority have shown to remain segregated, both socially and spatially after their migration to new location. From the above studies, it is obliviously that when the group of individuals identify themselves as being isolated or discriminated from the society they may opt to have strong ties within themselves thus result into asymmetric mode of resources and information sharing. The findings of the literature show the effect of this kind of interaction in which members of the same group have higher access to trade credit than outsiders, (Fisman, 2002; Fafchamps, 1999). This claim is supported with Biggs et al (2002) who analyse the role of ethnicity, information flow and contract enforcement in determining access to trade credit. In their analysis, they find that access for credit from formal sources of finance is not affected by ethnicity but being a member of ethnic group has an influence in obtaining informal credit. They conclude that ethnic networks act as information and contract enforcement mechanisms and therefore play a great role in access to trade credit between the two groups. Therefore, from the above studies, it is evident that ethnic networks create trust and familiarity which are crucial in promoting business among ethnic enclaves.

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2.4 Minority and Ethnicity

May et al. (2007) highlight the factors that can be used to differentiate the minority from the majority population. They claim that culture differences, effects of power discrimination and historical oppression on political and personal chance of true participation in politics and social activities are the factors that can differentiate the minority group. Furthermore, they argue that the lack of pure identity and if the minority group is not homogenous to the rest of the population and cannot be presented through the formal group structure, then the group is considered to be the minority group. Therefore in this study, minority entails the groups of people who have migrated to a new country having different culture settings from the locals and they can be identified with indigenous population because of their religious, race and interaction with the community. Consistently, May et al. (2007) claim that ethnic groups are defined in relationship to their social interactions with other groups, and the boundaries established and maintained between them as a result of these interactions. Furthermore they acknowledge that ethnicity is a social and culture construction that allow exploration of its articulation with other social forces. For that case ethnicity is regarded as an aspect of social relationships that can be analyzed in various ways in which individuals interact that can result in full identification of the social group. From the above differences between ethnicity and minority, this study compares the provision of trade credits between two groups found in Tanzania namely Chaggas-Tanzanians and Indians Tanzanians to provide clear picture whether ethnicity or minority has an influence in trade credit provision. This study is inline with Leighley (2001) who argue that, the factors that influence the behaviour of minority groups with that of majority white population do not allow for the comparative dynamics of minority in the United States contrary to Biggs et al. (2000) who compares minority (Indian-Kenyans) with the majority in Kenya, (African-Kenyans).

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They differ in race, religious and mode of interaction with the society. Chaggas are prominent in northern part of Tanzania occupying the southern and eastern slope of Mountain Kilimanjaro. They are considered to be wealthier and educated than other ethnic group in Tanzania. Chaggas believe they are superior to any other group and they have their own language commonly known as Kichaga, (Stambach, 1996). Most of Chaggas are Christians with few Muslims and other denominations6. Indian-Tanzanians are prominent in cities and urban centers of Tanzania. While Chaggas have dark skin, Indians are white in colour, originated from India thus differ from native Tanzanians. Most of Indians speak Swahili, English and Hindu while Chaggas speak Kichagga, Kiswahili and some can speak English. Because of their skin colour, religious and the differences in mode of interaction, Indians can be identified easily from the majority of Tanzanians therefore they are considered as minority when investigating the provision of trade credit Chaggas are considered to be ethnic group because they are among the tribes found in Tanzania.

To investigate the relationship between ethnicity, minority and the provision of trade credit, chapter 2 describes the theoretical background, chapter 3 provides explanation of the data and methodology used in the study while chapter 4 discusses the results before concluding in chapter 5.

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CHAPTER 3

DATA AND METHODOLOGY

This chapter discusses sampling procedures, collection of data and the methodology used in the analysis.

3.1 Sampling and Data Collection Procedures

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In carrying out the study, collection of the data was done using questionnaires, (See Appendix 1). Questionnaires were designed to be able to capture all information regarding the provision of credit and ethnicity together with the control variables that are useful in the study such as firm size, gender, length of relationships, business reputations and education of manager. For instance, respondents were asked to specify the ethnic group which they belong and were asked to provide information whether they have access for trade credit from suppliers of the same ethnic group or not.

Prior to the distribution of questionnaires to respondents, a pilot study was conducted in which fifteen questionnaires were distributed to academicians and business stakeholders found in Dar es Salaam. A pilot study was aimed at refining the contents of questionnaires before approaching the respondents. Additionally, a pilot study was intended to obtain inputs and insight of the reaction of the respondents before respondents are approached during the survey.

After a pilot study, some of questionnaires had to be translated to local language (Kiswahili) to ensure all the targeted firms/individuals are able to participate in the study and to have useful response from the respondent for whom the English language could have been a barrier to fill in the questionnaires, See Appendix 2. For that case, during data collection respondents were asked to choose the language which they thought it was most comfortable to them when filling in the questionnaires.

During the collection of data, the questionnaires were disseminated to business managers and owners of the firms of the three regions. Averages of 40 (forty) questionnaires were distributed to each region making a total of 120 questionnaires. This number was chosen because of time limitation for conducting the study and the geographical locations of the regions.

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questionnaires for 2-3 days to allow them to have sufficient time for filling in the questionnaire and to enable them to provide useful response for the study. Additional clarifications were provided when respondents encountered difficulties in filling the questionnaires.

Out of 120 questionnaires distributed, only 106 responses were received whereby 88 responses were received from the targeted sample (Chaggas and Indians) and the rest were from individuals with other ethnical background. This sample was then reduced to 72 responses after realizing that sixteen (16) questionnaires were not duly filled. This response makes approximately 60 percent of the distributed questionnaires. Of the 72 responses received, 29 responses were received from Dar es Salaam, 24 were from Arusha and 19 were received from Dodoma. Out of 72 responses received, 37 were the responses from Chaggas and the remaining 35 were from Indians. Below is the summary of the response received from the three regions;

Table 1; Number of response received from the regions.

Chaggas Indians Total

Dar es Salaam 16 13 29 Arusha 14 10 24 Dodoma 7 12 19 Total 37 35 72 3.2 Methodology 3.2.1 Descriptive

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explanations of the control variables used in the study such as gender, education and the length of business are presented in descriptive part of analysis. The variations of the control variables are also tested for the significant differences between the means of the two groups using ANOVA. Furthermore, Chi square test is employed to test whether the observed proportions for a categorical variable differ significantly from each other or otherwise, (Table 2).

3.3.2 Access to suppliers’ credit and Bank Overdraft

In the theoretical background, it has been shown that decision to offer credit is determined by screening of the characteristics of the borrowers such as creditworthiness and future potential of a borrower’s business. However, other studies have find that ethnicity is a useful tool in analysing the quality of a borrower and therefore it facilitates access for trade credit among members of the ethnic group, (Biggs et al. 2002 and Fafchamps, 1999).

In the second part of the result analysis, the variations of access to trade credit and bank overdraft are analyzed in a descriptively by comparing access to trade credit and bank overdraft of Chaggas-Tanzanians and Indian-Tanzanians. In examining such deviation, firm owners and business managers of the firms of two groups were asked if they have access for credit from suppliers of their main products and from the banks, (Table 3).

3.3.3 Investigation of access to credit using regression analysis.

In carrying out the study, the first hypothesis of the research; there is a positive relationship between the provision for trade credit and one’s belongingness to an ethnic group is examined. To investigate whether provision of credit between the two groups occurs on the basis of ethnicity or minority effect, the methodology used by Biggs et al. (2002) is followed.

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allowed them to pay cash or on credit, a dummy variable equal to one is assigned when the supplier allowed credit otherwise zero is assigned.

It is also known that being a member of the ethnic group is not the only factor that influences the provision of trade credit. There are other variables/characteristics that may have an impact on the provision of credit such as business reputations, size of the firms, length of business relationship between buyers and suppliers and the education of the managers, (Fisman et al. 2004).

To investigate whether provision of credit between the two groups is facilitated with ethnicity the following probit model is used, Biggs et al, (2002).

y*i = β'xi + ε

Where yi = 1 if a firm had access to trade credit and 0 otherwise.

Xi = Explanatory variables and ε is a random error term.

β = Parameter vector Where;

Xi1 = Size of the firm proxy with the log of number of employees.

Xi2 = Reputation of the firm proxy with the log of the age of the firm.

Xi3 = Trust of the business is estimated with the log of length of buyer-supplier

relationship.

Xi4 = Level of education of a manager equal to one if a manager has a post secondary

education and zero otherwise.

Xi5 = Gender, if a respondent is a male a dummy variable equal to one was assigned

otherwise zero.

All the control variables used in the analysis are expected to have positive relationship with access to credit, Biggs et al (2002).

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suppliers are more likely to be confident with a firm with large size than the smaller firm in extending trade credit presuming the risk of default for large firms is lower than the smaller firms..

The age of the firm which estimates the reputation of the firm is also expected to be positively related with access to credit because as the firm becomes older it becomes easier to get its information and the risks of becoming insolvency is lower than the younger firms, (Biggs et al. 2002). Therefore suppliers are more likely to offer trade credit to older firms than younger firms.

It is also expected that education of the firm’s manager/owner to be positively related to access to credit since as the manager becomes well educated, it is possible to handle the firm in a profitable way thus facilitate access to credit, (Coleman, 2002).

The positive relationship is also expected to be observed with the length of the relationship between suppliers and borrowers because when parties are in relation for long, information including private information regarding credit rating/worthiness becomes readily available to the lender thus facilitate the provision of credit, (Cunat, 2006)

To examine whether trade credit is provided on the basis of one belonging to a group, a dummy variable equal to one is assigned for an INDIAN firm and a zero to a Chaggas.

Multicollinearity

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Ordinary Least Square and Heteroscedasticity

To examine the influence of ethnicity in the provision of trade credit, the regression equation is modeled under the assumptions of an Ordinary Least Square (OLS) .The assumptions of OLS in terms of the error terms are as follows; the mean of error terms is zero, the variance of error term is constant, covariance of error terms is zero and the error terms are normally distributed, (Brooks, 2002). In carrying out the analysis, access to trade credit is used as the dependent variable while firm’s specific data, the information of owners and managers of the firms and the three sector dummies are used as the independent variables.

Before analyzing the model, the data set are tested for heteroscedasticity. If heteroscedasticity does exist, it implies that the error terms do not have a constant variance. The consequence of heteroscedastic errors is that the coefficient estimates can no longer have the minimum variance among the class of unbiased estimators; therefore the standard errors can be wrong. To avoid wrong standard errors estimate, White’s general test for heteroscedasticity (with no cross terms) is used to examine the presence of heteroscedasticity, (Brooks, 2002). Appendix 4

After testing for the heteroscedasticity, the dependent variable, access to trade credit (acc) is regressed with the independent variables using the assumptions of heteroscedasticity. The independents variables are Indian, log of number of employees (log_e), log of age of the firm (loga), gender, education (educatn) and the three sector dummies, Table 4a. To ensure the control variables donot have an impact to ethnicity, the variable size is interacted with ethnicity, Table 4b.

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assigned otherwise 0 is given. This investigation is carried out in conjunction with other control variables that may accelerate the provision of bank overdraft such as firm size, reputation of the firms and education of the manager or firm owner together with the variable Indian, Table 4a. In doing the analysis of bank overdraft, the variable size is interacted with the variable Indian to examine whether size has an impact on ethnicity, Table 4b.

In carrying out the study, the third hypothesis of the research; Indians firms which are considered to be the minority have higher access to trade credit than Chaggas firms. To investigate whether access to trade credit is influenced with ethnicity, firm managers and business owners were asked whether they thought their access to suppliers’ credit was due to them being a member of the same group with their suppliers. A dummy variable equal to 1 is assigned if the access to credit was thought to be because of belongingness to a group with the lenders other wise zero is given. The same question was extended to bank overdraft and a dummy variable equal to 1 is assigned if access to bank overdraft was believed to be the result of ethnicity, otherwise zero is given. To remove the effect of dummy variable to pick the explanations that could have been given with other variables, control variables such as reputation of the firms, size of the firms and education of manager/owner of the firms are included in the analysis. Before analysing the data, the regression model is tested for the presence of heteroscedasticity. The results are presented in Appendix 5. The variable ethnicity is then interacted with the log of age of the firm to examine whether the age of the firm has an impact on ethnicity, Table 5.

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CHAPTER 4

RESULT ANALYSIS

This chapter analyse the result of the provision of trade credit between two ethnic groups, Chaggas and Indians-Tanzanians.

In Section 4.1 the descriptive statistics of the dataset are presented and the characteristics of the data are discussed. In section 4.2 the variation of access to credit between the two ethnic groups are descriptively analyzed and discussed while section 4.3 discusses access to credit in relation to ethnicity for the two groups using regression analysis.

4.1 Descriptive Statistics.

Table 2 Distribution of Variables

Table 2(a) Variation of industry between the two groups (p= 0.193, F = (15.000)

Indians Chaggas

Number of firms Percentage Number of firms Percentage

Textiles 5 14.3 8 21.6 Food 6 17.1 5 13.5 Construction 2 5.7 4 10.8 Metal 4 11.4 7 18.9 Electronics 10 28.6 3 8.1 Wood 4 11.4 8 21.6 Others 4 11.4 2 5.4 Total 35 100 37 100

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The above table shows that there is a variation in the number of firms included in the study with Indians firms being 35 while Chaggas firms are 37. Furthermore, the table shows that, there is variation in the representation in type of industries between the two groups. Indians firms are highly represented with electronics (28.6%) and least represented with wood and metal (11.4%) while Chaggas are highly represented with wood and textiles firms (21.6%) with electronics firms being least represented,( 8.1%). However the variation in proportional of representation is not significant.

Table 2(b) Firms distributed based on the forms of trading (p = 0.000, F =1.000)

Indians Chaggas

Number of firms Percentage Number of firms Percentage

Retailers 9 25.7 12 32.43

Whole sellers 19 54.3 11 29.73

Manufacturers 7 20.0 14 37.84

TOTAL 35 100 37 100

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Table 2(c) Variation in number of employees (p= 0.124, F = 1.904) Indians Chaggas Average 8.70 6.041 Standard deviation 10.51 4.513 Min 3 3 Max 48 17 Median 8 3

From the above Table 2(c), it can be seen that there is a difference in number of employees between the firms of the two groups, Indians and Chaggas. While Indians firms have average of 9 employees per firm, Chaggas have approximate 6 employees per firm (about 2/3 of Indians firms). Using the number of employees as proxy for the size of a firm, it is possible that in average Indians firms are large than Chaggas’ firms contrary to the observation in the forms of trading. However the difference in size between the two firms is not significant.

Table 2(d) Variation in length of buyers- suppliers relationship in years (p=0.853, F= 0.429) Indians Chaggas Average 6.93 7.162 Standard deviation 5.52 4.582 Min 2.5 2.5 Max 31 20 Median 7.5 7.5

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ground that if suppliers have longer relationship with their borrowers, it becomes easy for them to get information (including private information) about their borrowers’ creditworthiness thus Indians firms have higher possibility of accessing trade credit.

Table (e) Variation in length of business in years (p=0.896, F =0.362)

Indians Chaggas Average 8.96 8.081 Standard deviation 5.87 4.974 Min 2.5 2.5 Max 31 23 Median 7.5 7.5

The differences in length of existence for business of the two groups provide additional support in favour of Indians firms in terms of accessing trade credit. Tables 2 (e) indicate that the average age of business for the Indians firms is approximate 9 years while that of Chaggas is about 8 years. The difference in length of being in business provides additional credibility for the Indians firms than for the Chaggas firms because it is believed that if a firm has been operating for longer time the possibility of becoming bankrupt is lowered. However the variation in length of business for the two groups is not significant.

Table 2(f) Variation in gender and level of education

Indians Chaggas P-value F-stat.

Number % Number % 0.000 1.000

Male in business 24 68.57 28 75.68 Post sec education 27 77.14 18 47.37

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which is less for about 30% from Indians firms. The difference in level of education may also favour Indians in terms of access to credit because lenders and suppliers may believe that educated people are the ones who are capable of controlling firms in a profitable way thus allowing more access to trade credit for Indians firms than their counterparty.

The difference in gender between the two groups may have an impact on the provision of credit. It is believed that most of Indian firms are owned or controlled by families therefore family succession is not a problem to Indians compared with Chaggas where firms are mostly owned by an individual within a family which in turn could to difficulties in succession. When there is high possibility of smooth transfer of ownership or when the firm is owned by the family, then there is higher probability of the firm to exist longer. If a firm has higher possibility of existing longer, it implies that it has more possibility of having higher access to trade credit because of the confidence the suppliers have on the firm. Therefore, the variation in gender between the groups’ shows that most of Indian firms are owned by families thus provides additional support in favour of Indians firms to access trade credit.

4.2 Access for suppliers credit and bank overdraft

This section discusses the variation in access for suppliers’ credit and bank overdrafts for the two groups.

Table 3 Access to suppliers’ credit and overdrafts (p =0.000, F = 1.000)

Overdraft Trade credit

Chaggas 48.65% 67.57%

Indians 82.86% 91.43%

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making the difference of 23.86% while the difference in bank overdraft between the two ethnic groups is more pronounced, 34.21%. There are possible reasons that could have driven up these differences. One of the reasons of such diversity in the provision of trade credit between native Tanzanians and Indians-Tanzanians could have been built by the reason that provision of trade credit among Chaggas and possibly other native Tanzanians is more practised within families and not among individuals of the same ethnicity. While for Indians, access to suppliers’ credit could have been enhanced with their race or minority and therefore credit is extended beyond the family level. Furthermore, the difference in access for overdraft between the groups could have been attributed by variation in qualities of the variables between the two groups. For instance, out of 38 Chaggas approached only 18(47.37%) have post secondary education while for Indians, 27 out of 35 respondents have post secondary education ( 77.14%), it is possible that the qualities of Indian firms impact the provision of credit. To provide clear understanding of the difference in access of credit for the two group regression analysis is applied.

4.3 Access to credit using regression analysis

The following is the model that estimates access to trade credit and bank overdraft. The variable access to credit is substituted with trade credit when estimating accessing to trade credit and substituted with bank overdraft for access to bank overdraft estimation. The results of the estimates are in table 4(a).

1. Access to credit = α + β1 [log (firm’s age)] + β2 [(log (number of employees)] + β3

[Education dummy] + β4 [Gender dummy] + β5 [Metal dummy] + β6

[Textile dummy] + β7 [Wood dummy] + u

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Table 4 Access to credit using probit model

(a)

Explanatory Variables Access to trade credit Access to Bank overdraft

Coefficient (standard error) P-value Coefficient (Standard error) P-value Intercept 0.241 (0.192) 0.2142 -0.385 (0.097) 0.465 Wood 0.104 (0.136) 0.4472 0.187 (0.122) 0.129 Textile 0.170 (0.126) 0.1827 0.108 (0.121) 0.374 Metal 0.006 (0.137) 0.9640 0.119 (0.124) 0.342

Size of the firm (log of employees’ number). -0.030 (0.158) 0.8493 -0.197 (0.164) 0.233 Gender 0.178 (0.121) 0.1460 0.097 (0.098) 0.328

Reputation of the firm (log of age of firms)

0.220 (0.207) 0.2909 0.980 (0.176) 0.000 Education of firm owner/business manager 0.150 (0.095) 0.191 0.071 (0.097) 0.465 Indian 0.202 (0.095) 0.0371 0.297 (0.090) 0.002 Adjusted R-squared 0.139 0.437 F-statistics 2.43 7.88 Observation 72 72

To investigate whether the variable Indian has an impact on size of the firm, the variable Indian is interacted with size and estimated as follows;

2. Access to credit = α + β1 [log (firm’s age)] + β2 [log (number of employees)] + β3

[Education dummy] + β4 [Gender dummy] + β5 [Size X Indian] + β6

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The results of the model are in table 4(b)

4(b)

Explanatory Variables Access to Trade Credit Access to Bank overdraft

Coefficient (standard error) P-value Coefficient (standard error) P-value Intercept 0.265 (0.240) 0.275 0.363 (0.191) 0.062 Wood 0.101 (0.140) 0.474 0.185 (0.124) 0.140 Textile 0.170 (0.128) 0.188 0.108 (0.122) 0.379 Metal 0.006 (0.139) 0.967 0.119 (0.125) 0.347

Size of the firm (log of employees’ number). -0.064 (0.257) 0.804 -0.228 (0.226) 0.318 Gender 0.176 (0.120) 0.148 0.096 (0.099) 0.340

Reputation of the firm (log of age of firms)

0.220 (0.207) 0.290 0.980 (0.178) 0.000 Education of firm owner/business manager 0.151 (0.115) 0.196 0.072 (0.097) 0.464

Interaction of size and Indian 0.057 (0.262) 0.830 0.052 (0.260) 0.844 Indian 0.162 (0.235) 0.4930 0.260 (0.205) 0.211 Adjusted R-squared 0.126 0.501 F-statistics 2.13 -23.737 Observation 72 ₇₂

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to the access to bank overdraft, implying that as the size of the firm increases access to bank overdraft increases.

To provide clear explanation whether ethnicity has an influence in the provision of trade credit, the variable ethnicity is included in the regression model;

[Education dummy] + β4 [Gender dummy] + β5 [Ethnicity dummy] +

β6 [Indian dummy] + u

The results of the above equation are presented in table 5(a). The results shows that access to trade credit is positively significant related to ethnicity at 1% level of significance, implying that ethnicity has a positive influence on the provision of trade credit. When the same test is conducted for bank overdraft, the result shows that ethnicity is positively related with access to bank overdraft however the relation is not significant. Furthermore, the result reveals that Indian firms have greater access to bank overdraft at 1% significant level while access to trade credit by Indians is not more pronounced, 10% level of significance. Similar to table 4, age of the firm is positively significant related to bank overdraft implying that as the age of the firm increases, access to bank overdraft increases because the risk of insolvency is narrowed as the firm becomes older.

To examine whether the variable reputation of the firm which is proxy by the log of age of the firm has an impact on ethnicity, the two variables are interacted and they are modelled as follows;

β6 [Ethnicity X log (firm’s age)] + β7 [Indian] + u

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Table 5 The effect of ethnicity in access to trade credit and Bank overdraft

5 (a)

Explanatory Variables Access to trade credit Access to Bank overdraft Coefficient (standard error) P-value Coefficient (standard error) P-value Intercept 0.191 (0.181) 0.294 -0.300 (0.140) 0.037

Size of the firm (log of employees’ number). -0.040 (0.137) 0.769 -0.163 (0.158) 0.306

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Table 5(b)

Explanatory Variables Access to trade credit Access to Bank overdraft Coefficient (standard error) P-value Coefficient (standard error) P-value Intercept 0.050 (0.287) 0.863 -0.298 (0.140) 0.036

Size of the firm (log of employees’ number). -0.010 (0.140) 0.946 -0.188 (0.158) 0.240

Reputation of the firm (log of age of firms) 0.374 (0.374) 0.260 1.028 (0.182) 0.000 Education of firm owner/business manager 0.123 (0.104) 0.241 0.046 (0.098) 0.638 Gender 0.144 (0.109) 0.194 0.083 (0.098) 0.401 Ethnicity 0.562 (0.319) 0.083 1.637 (1.391) 0.244 Indian 0.139 (0.088) 0.120 0.307 (0.093) 0.002

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The result in Table 5(b) shows that ethnicity has an influence in trade credit even after the interaction of the variables. However the relationship is not strong (10% level of significance). Furthermore, the result shows that Indian firms have higher access to bank overdraft at 1% significant level, similar to table 5 (a)

In carrying further investigation, the data related to the two groups are separated and analysed independently. For that case the variable Indians is eliminated from the regression model 4 and the following model is estimated.

β6 [Ethnicity X log (firm’s age)] + β7 [Indian] + u

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Table 6 Access to suppliers credit for Chaggas and Indians-Tanzanians

Explanatory Variables Access for trade credit (Chaggas)

Access for trade credit (Indians) Coefficient (standard error) P-value Coefficient (standard error) P-value Intercept 0.143 0.292 0.629 0.427 (0.261) 0.112

Size of the firm (log of total number of employees). -0.058 (0.254) 0.819 0.018 (0.155) (0.911)

Reputation of the firm (log of age of firms) 0.197 (0.247) 0.429 0.136 (0.270) 0.617 Education of firm owner/business manager 0.175 (0.140) 0.223 0.099 (0.141) 0.491 Ethnicity 0.338 (0.157) 0.040 0.278 (0.140) 0.050 Gender 0.196 (0.204) 0.341 0.121 (0.108) 0.274 Adjusted R-squared 0.140 0.239 F-statistics 2.166 3.131 Observation 37 35

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CHAPTER 5

CONCLUSION`

Trade credit commonly known as “mali kauli” in Tanzania is an important source of short term liquidity for most firms in developing country, (Fafchamps, 1999). Various trade credit theories have explained the motives for provision of suppliers’ credit. However the motives are inconsistent with some situations existing in some countries where ethnicity has found to have an influence on the provision trade credit, (Biggs et al. 2002 and Fafchamps, 1999). The influence of ethnicity on the provision of trade credit is facilitated with the presence of information asymmetry, uncertainties regarding parties in the transactions and difficulties in enforcing contracts. McMillan and Woodruff (1999) explain that in developing and transition countries laws are incapable of enforcing contracts, thus informal relationship is used as substitute for the courts to facilitate deals between parties.

This thesis studied access to trade credit between two prominent groups that are engaging in trade activities in Tanzania through investigation of the strength of the informal relationship that exist between the two groups. The study aimed at finding if the superior access for trade credit to Indians-Africans is the result of ethnicity or minority effect.

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found to show that Indians firms have higher access for trade credit than Chaggas firms. Therefore, no difference is found between minority and ethnicity influence in access to trade credit.

5.1 Recommendation for further Studies

In addition to the findings, there are areas that need to be further investigated to provide clear understanding of the influence of ethnicity on the provision of trade credit. It has been found out that in both groups ethnicity has positive significant relationship with the provision of credit at 5% level of significance. The following areas need to be examined in further studies;

Firstly, this study uncovers the relationship of provision of trade credit between medium and large firms of the two groups. For instance, in Tanzania there are firms with more than 300 employees (SGS superintend Company, TBL and Bakhressa). Thus the question remains whether the pattern created hold with other size of firm or not. Therefore, further study need to be carried to provide a clear picture whether this relationship is uniform throughout or otherwise because as the firms size becomes larger more formal procedures are implemented therefore the effect of ethnicity can be eliminated.

Secondly, the study is limited to 72 firms comprising of both groups. This was due to limited time of carrying out the study. More samples need to be added to the study to ensure efficiency representation of the groups. Further more, information that has been used in the study relates to only one side of the transactions, buyers. There is a need to investigate the provision of credit within the groups by taking into account both parties in the transactions to ensure the accuracy of the information.

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The Influence of ethnicity on the Provision of Trade Credit

The Influence of ethnicity on the

Provision of Trade Credit

An empirical analysis of access to trade credit for the two

ethnic groups in Tanzania

Name: Hassan

A.

Ibrahim

Student number: S.1660586

August 2007

UNIVERSITY OF GRONINGEN

Faculty of Management and Organization / Economics

MSc Finance

The Influence of ethnicity on the

Provision of Trade Credit

An empirical analysis of access to trade credit for the two

ethnic groups in Tanzania

Abstract

Table of contents