Discussion Papers

" . ,.

The Enforcement of Commercial Contracts in Ghana

Marcel Fa/chomps

RPED Paper No. 22

The views and interpretations expressed in this study are solely those of the author. They do not necessarily represent the views of the World Bank or its member countries and

I should not be attributed to the World Bank or its affiliated organizations.

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1

The> Enforcement of Commercial Contracts in Ghanal

Marcel Fafchamps

Stanford University

March 1994

Commercial contracts for the delivery and the sales of goods are a good deal more

complicated than the elementary market transactions portrayed in economic textbooks. Firms must

be able to place and take orders, to arrange the future delivery of goods and services, to dissociate

the timing of payment from the physical delivery of goods, and to seek or provide warranty. Cash­

and-carry transactions make the conduct of business unwieldy and cumbersome, except perhaps

for extremely small enterprises. By entering into contracts with delayed obligations firms put

themselves partly at the mercy of contractual partners. The whole production process may come

to a halt if essential inputs are not delivered on time. Inputs of deficient quality could result in

inferior output and damage the equipment. Late payment by clients deprives the finn from

necessary working capital. A single bad debt may wipe out the profits made on many transactions.

To prosper firms must be able to rely on their business partners. The existence of contract

enforcement mechanisms is therefore a necessary condition for a vibrant business community to

develop (North (1990), Benson (1990». Without a conducive business environment,

manufacturing and other forms of economic activity cannot flourish.

This paper documents how commercial contracts are enforced in Ghana. It is based on a

World Bank case study of enterprise finance and contract enforcement conducted in January 1993.

The study is part of an ongoing effort undertaken by the Regional Program for Enterprise

Development (RPED), Africa Region, to understand the environment in which manufacturing

firms operate in Sub-Saharan Africa and to propose ways of promoting their development (The

World Bank (1992».2 Strengthening institutions that enforce commercial contracts is one of

several avenues to improve the business environment in Africa.

II thank Tyler Biggs, Peter Moll, Pradeep Srivastava, Rebecca Hanson, Scott Pearson, and the Review's referees and editors for their useful comments. All remaining errors are mine. The research on which this paper is based was fmanced by the World Bank.

2Since this article was written, a similar study of enterprise finance and contract enforcement was conducted in Kenya (Fafchamps et. aI. (1993), Results confirm Ghanaian fmdings. Another country srudy is scheduled for the Summer of 1994,

2

Credit from suppliers or customers is also the major form of credIt to which many small

and medium firms have access: credit from suppliers and advances from customers represent two

third of the total debt held by Ghanian firms with less than fifty workers (Cuevas et. a1. (1993),

p.9). Bank loans and overdraft facilities make a major financial contribution to large firms, but

account for only 7 and 24 percent of the total debt held by small and medium finns, respectively.

Firms with access to bank credit, particularly overdraft facilities, use it in part to finance trade

credit to other finns (ibidem). Assisting the enforcement of commercial contracts can thus favor

the use of trade credit, help small and medium firms grow by making more credit available to

them, and speed up African economies' response to changes in relative prices as a result of

structural adjustment (Steel and Webster (1991».

This paper is organized as follows. Key concepts are introduced in the first section. The

relationship between the need for contractual flexibility, trust, and reputation is emphasized.

Survey results from Ghana are presented in section two. Lessons from the survey are discussed

in section three. Legal and institutional changes are suggested that should increase the willingness

of Ghanaian firms to grant trade credit, even to firms or individuals with whom they have not

done business before. Thinking about commercial contracts in terms of enforcement not only helps

understand many African business practices. It also constitutes an entry point into policy making

by establishing a much needed link between the practice of law and the economic theory of

institutions .

Section 1. Concepts

Contracts are not respected whenever economic agents are unable or unwilling to comply .

with their obligations.3 Willingness to comply is assured only if an enforcement mechanism exists

that penalizes breach of contract. Enforcement mechanisms come in three varieties: those based

on guilt, those based on coercion, and those based on repeated interaction. Mechanisms based on

gUilt are internal to each individual. They depend on one's ability to feel guilty for failing to

respect promises. Honesty is largely the byproduct of upbringing, what psychologists call

'secondary socialization' (platte au (1991». It is also influenced by cultural values and religious

beliefs. Enforcement mechanisms that rely on coercion are of two types: legitimate and

illegitimate. The legal enforcement of contracts through courts and tribunals ultimately relies on

3Unwillingness to comply with contractual obligations is what McKinnon calls 'strategic default' (1973). Laywers refer to it as 'opportunistic breach of contract'.

3

the state's monopoly of the use of legitimate force. It is the backing of legitimate force that allows

a creditor to seize a debtor's assets and therefore grants a collateral value to unmovable property

like land and buildings. Illegitimate force can also be used to enforce contractual obligations.

Parties may resort to insult and violence directly, or call upon the services of anned men -- e.g.,

hire thugs, bribe soldiers and policemen. Whether legitimate or illegitimate, the use of coercion

to enforce contracts is costly. For small transactions the cost of legal proceedings is typically too

high to justify court action.

The third type of enforcement mechanism is based on quid pro quo: 'I shall continue to

behave if you continue to behave' (Axelrod (1984), Fudenberg and Maskin (1986».4 For such a

mechanism to work, parties must interact repeatedly over time. It is the threat of future

punishment that makes economic agents comply with their contractual obligations. Punishment

takes various fonns. The simplest of them is the refusal to further transact on the same terms. For

this punishment to have an effect, the relationship must something worth preserving. Punishment

may also be inflicted by members of a group who were not party to the non-respected contract.

Any group punishment requires a coordination mechanism and the circulation of information about

contract compliance within the group (Kandori (1992), Raub and Weesie (1990». Reputation is

that coordination and infonnation sharing device. Any enforcement mechanism based on

reputation is vulnerable to disinfonnation. It does not operate well unless a complementary

mechanism exists that ensures the quality of the shared infonnation.

Some of these concepts are now illustrated fonnally. Consider a contract by which an

economic agent, called the debtor, promises f at time 1 to another agent, called the creditor, in

exchange for k at time O. Here, f may be a payment or a delivery, k the transfer of goods or an

order for future delivery. Parties value k and f differently so that they are potentially gain from

trade for both of them.s At time 1, the debtor decides whether to comply with the contractual

obligation and receive a payoff Jl(-f, 1; e), or to breach the contract and receive a payoff Jl(b, 1;

e) but incur punishment. Payoffs depend on the debtor's type 'TE..1 as well as on a state of nature

eEIunknown at time 0 but realized at time 1. We assume that..1 and Iare common knowledge;

4 Applications of this type of enforcement mechanism to contracts flIst appeared in the literature on sovereign borrowing (Eaton and Gersovitz (1981), Kletzer (1984), Grossman and van Huyck (1988».

SWe assume that suppliers like to receive orders because it allows them to reduce stocks and organize production better.

4

'l'is known only to the debtor. We consider four forms of punishments: gUilt G('l', e), legal

sanctions P(r, e, C), suspension of future trade with the creditor resulting in the loss of discounted

future payoff EV(e, 'l'), and damage to reputation with other potential trading partners leading to

a loss of trade EW(e, 'l'). The penalty inflicted to the debtor by each of the possible punishments

depends on the debtor' s type 'l' and on the realized state of nature e. The legal penalty also depends

on the form of the contract C. If the cost of legal procedings is higher than C, the creditor cannot

credibly threaten to sue and P(r, e, C) =0. A rational debtor complies with contractual obligations

if the short-term gain from breaching the contract is larger than all punishments combined:

(1) neb, T,e) -n( -f, 't,e) ~ EV(T,e) +EW('t,e) -G('t,e) -PC 't,e,C)

In some states of nature e, tr(-j. r, ~/) = -co. The debtor is then said unable to pay. In others, tr(-

f, r, e) > -00 but equation (1) is not satisfied. The debtor is then said able but unwilling to pay.6

The creditor, in tum, parts with k in exchange for a future promise off Let Il(-k) and a(f) be the

value of I and k to the creditor; a(f) > a(-k). In forming beliefs about the probability of getting

I, a rational creditor evaluates the probability that equation (1) will be satisfied given all the

information n available to him at time 0; n combines priors about the distribution of potential

debtor types, information gathered over time through direct interaction with the debtor, and

information conveyed by others about the debtor. The creditor agrees to contract if:

(2) E(IJ(f)IO)-II(k) > 0

Equations (1) and (2) encompass many information issues. Moral hazard occurs whenever

the state of the world e depends on the debtor's costly action a (Greenwald, Stiglitz and Weiss

(1984». Success in business is largely function of the diligence and care with which ftmlS conduct

their operations. Moral hazard is thus likely to be present in business contracts. The potential for

6The disctinction between inability and unwillingness to repay is blurred in practice. For equity reasons,

debtors often are regarded as unable to repay when 7t{-f, ~ e) fall below a socially unacceptable level B>-.

5

adverse selection is there as well. Suppose that E(r) so that certain types of economic agents are

more likely to be unable to pay than others. Agents who are bad risks would find it in their

interest to assume contractual obligations knowing that there is a high probability they will be

unable to satisfy them. As a result, trade credit may need to be rationed (Stiglitz and Weiss

(1981». Because of moral hazard and adverse selection, the boundary between inability and

unwillingness to comply with bonafide contractual obligations, while (somewhat) precise ex post,

is blurred ex ante: any breach of contract is potentially the result of opportunistic behavior. If, for

instance, the penalty for breach of contract is infinite, no one will enter into any contract without

being absolutely certain of being able to comply. 7 Moral hazard and adverse selection would be

prevented. The potential for moral hazard and adverse selection thus also depends on penalties for

noncompliance.

The simple model captured by equations (1) and (2) can be used to throw light on a variety

of behaviors, many of which were uncovered during the survey. The effectiveness of punishment

mechanisms and the ability to comply with contractual obligations depend on someone' s type r,

in particular whether one is a fly-by-night operator or an experienced business concern with a high

probability of being able to comply Etr(-j. T, e) and a high interest in future trade EV(r, e)

(Williamson (1985». It may thus be optimal to acquire costly information about someone's type.

Suppliers, for instance, investigate potential clients by visiting their workshop and socializing with

them. They assess their clients' competence and business potential F(tr(-f, z; e)) by observing how

regular and large purchases are and how clients bargain on price and quality. They test clients I

honesty G(T, e) and interest in a continued relationship EV(r, e) by selling small quantities on

credit over a period of time and observing whether payment is forthcoming. Creditors may also

rely on easily observable characteristics like sex, race, or ethnicity to infer someone's type. Small

differences in population averages can then lead to statistical discrimination (Coate and Loury

(1993» and induce the domination of certain ethnic groups over particular sectors of activity

(Macharia (1988), Fafchamps et. a1. (1993». Debtors may differentiate themselves by acquiring

a costly signal a that is correlated with their true type r. For instance, they may join religious

7Except if one is already faCing a certain prospect of infInitely negative utility. Someone who is starving, for instance, may borrow money even if failure to repay is punished by death.

6

groups or activities to impress potential creditors of their higher ethics G(r. e) (Cohen (1969),

Geertz, Geertz, and Rosen (1979».

As economic agents learn about each other and update their priors n, they begin to trust

each other (Gambetta (1988), Fafchamps (1992b». Trust can be thought of as a social capital that

can be accumulated over time through 'good' actions and dissipated through 'bad' actions

(Coleman (1988». Now consider a risk averse firm that has identified a few reliable business

partners. The information n the firm has accumulated on its partners is more precise than ..1, the

information it has on the general population of potential trading partners. Reliable partners are

also probably better than the average population ..1 because they are the result of a selection

process. Therefore n stochastically dominate..1: because it is risk averse, the finn prefers to deal

with known partners than with unknown firms (Arrow (1971». The reluctance to deal with

newcomers in the same way (trade credit, checks, orders) as old partners leads to personalized

exchange: networks are formed, cliques established, and firm entry and competition stifled

(Lorenz (1988), Fafchamps (1992c».

Enforcement mechanisms that operate within a large group, namely, legal enforcement and

reputation, nevertheless enable finns that have not established personalized relations to deal with

each other in a business-like fashion. Large transactions with a well defined legal enforcement

mechanism based on unmovable collateral or other formal guarantees C do not require prior

personal acquaintance; they rely on a high P(r. E, C). Bank loans fall within this category. Firms

may also rely on reputation. Reputable firms who belong to an information sharing group have

a high EW(r. e) with all the finns in that group, irrespective of whether they have dealt with them

in the past or not. This may be sufficient to ensure that equation (1) holds and to generate

sufficient confidence for business-like transactions right from the start (Greif (1993), Milgrom,

North and Weingast (1991». Firms within the information sharing group are thus at an advantage

relative to firms who outside of it (Fafchamps et. al. (1993». The larger the group among which

reputation is shared, the larger the group of potential business partners, and the more access finns

have to a safe business environment.

The desire to discourage opportunistic behavior through better enforcement may, however,

conflict with the need for risk sharing. Business around the world, but particularly in Africa, is

subject to shocks. Cash flows vary in unpredictable ways. Firms with insufficient access to

7

insurance and credit from other sources often fmd themselves unable to honor precise deadlines

for payment and delivery. Too strict a stance on contract enforcement would be counterproductive

for both parties, and Pareto inferior from society's point of view (Zame (1993». Many cases of

noncompliance are probably 'excusable' in the sense of Grossman and van Huyck (1988) in that

they were anticipated and implicitly accepted ex ante by the other party (see also Eaton and

Gersovitz (1981), Kletzer (1984) and Udry (1990». One would therefore expect to observe either

state<ontingent, flexible contracts in whichf(e). In practice, state-contingent contracts are difficult

to write and e is seldom verifiable by judges. Instead, parties may implicitly agree beforehand to

renegotiate ex post their contractual obligations whenever they find compliance difficult or

unfairly costly. Whenever contract renegotiation remains within 'reasonable', that is, implicitly

agreed upon boundaries, parties are likely to resume business afterwards. If one party makes

demands beyond what the other party fmds acceptable, the relationship is more likely to end.

For risk sharing through contract renegotiation to be possible, however, creditors must be

able to observe or verify e, that is, whether a debtor is truly unable to comply with contractual

obligations or not. Otherwise a recalcitrant debtor could falsely pretend to be unable to pay.

Debtors may be dissuaded from making false claims by increasing the penalty for default, but this

conflicts with insurance and equity objectives. In practice, costly monitoring of eby creditors is

often required for risk sharing to take place (Fafchamps (1992a». Understanding how actual firms

in Ghana handle these complex issues of contractual enforcement, information imperfection, and

risk sharing is the object of the next section.

Section 2. Survey Results

Fifty eight Ghanaian firms were interviewed in January 1993 by a team of Ghanaian

scholars and World Bank: researchers. Questions were asked regarding the importance of trade

credit in the financing of the firms' working capital requirements and the problems and difficulties

firms encounter with suppliers and clients. Forty of the surveyed firms were selected from a panel

of roughly two hundred Ghanaian manufacturing firms currently participating to an RPED study

of enterprise development in Ghana. They are divided equally among four sectors of economic

activity: wood processing, food processing, textile and garment, and metal works. The rest of the

sample consists of suppliers and clients of these firms and of trading firms randomly selected on

local markets.

8

Given our initial state of ignorance regarding mechanisms for contract enforcement

prevailing in Africa, a case study approach was adopted. The section of the questionnaire dealing

with contracts was mostly used as a conversational guide. Respondents were quizzed on their

motivations and beliefs regarding suppliers and clients. Past contractual problems were discussed

in detail. To avoid biases resulting from fums' reluctance to speak about contractual problems in

which they were at fault, questions were limited to non- or late delivery by suppliers, deficient

quality of supplied goods, and non- or late payment by customers. Given the nature of the issues

raised, body language was an important part of respondents' anwers. Several laughed or shrugged,

for instance, when asked why some of their clients had no paid them, thereby implying a

suspiscion of carelessness even if their verbal answer did not mention it. Many of the respondents'

answers have been codified. They are presented in Tables 1 through 10 in appendix. The

discussion that follows also builts upon the rich body of qualitative information gathered during

the interviews. Although the small size and diversity of the sarp.ple makes it difficult to draw

statistically significant inferences, a detailed even if preleminary picture of contract enforcement

in Ghana is nevertheless obtained. Contractual relations between firms and their clients are

reviewed first. Relations with suppliers come next. Strategies used to prevent problems are then

discussed. The use of legal institutions is discussed at the end.

Relations With Clients

Non-Payment and Late Payment by Clients

Firms were asked about non-payment and late payment problems encountered with clients.

Their answers are summarized in Table 1 and 2 respectively. Firms were also asked to comment

on the most recent problem they had experienced with a client. Answers are these questions

presented in Table 3. Non-payment by clients affected 30 out of the 52 fIrmS that answered the

question (Table 1). In most cases, non-payment occurs after delivery has taken place. Exceptions

are when customers fail to pick up an order. Bounced checks are cited only in a few cases. Late

payment, on the other hand, affects all firms (Table 2). It is also the most cited recent problem

with a client respondents could remember (Table 3). All credit sales contract seem to implicitly

allow late payment. Delays of a few days are so common that they are not even mentioned by

respondents unless specifically prompted. In one fifth of all credit sales, no specific term is even

set for payment. For those instances when respondents considered clients had paid late, the

average delay ranged from 6 weeks for manufacturing firms up to 20 weeks for traders. This

compares to an average payment term of 3 to 4 weeks for those contracts where a payment term

9

was specified. Problematic clients never are a family member or relative (Table 3), but the survey

recorded no credit sales to family members and relatives. In three-fourth of the cases the

transaction with that particular client was not the first. On average, the respondent firm has been

doing business with the problematic client for over 4 years (Table 3). This compares to an average

of 6 years of acquaintance with clients receiving credit.

Late payment or non-payment occur only when an element of credit has entered the

transaction. Credit may be voluntary, or it may be forced upon the respondent. In one case out

of five -- one out of four with traders -- late payment is associated with bounced checks. In a

number of non-payment cases, respondents said they were • conned I by customers into delivering

the goods on the promise of very prompt payment. The circumstances of each case vary, but the

result was the same: firms were reluctantly, but somewhat knowingly, dragged into a situation of

extending credit to their customers. In half the cases, partial or advance payment was made so that

the loss from non-payment was partial only.

Reasons for non-payment fall into two broad categories -- upstream transfer of risk, and

cheating (Table 1). Half the respondents indicate financial difficulties of clients as the major

reason for non-payment. In one case out of five, firms specifically state that clients were unable

to sell the goods supplied by or made from goods supplied by the respondent, or that they were

unable to collect payment for such goods. Clients thus shared commercial risk with their supplier.

In a third of the cases, respondents blame dishonesty as the reason for non-payment. Other

spurious reasons for non-payment, such as "the client had to travel", "the client moved" or "the

client left that line of business" are also advanced by respondents, often with suspicion of

dishonesty .

Late payment, on the other hand, is mostly a way of sharing commercial risk with the

supplier (Table 2). It is overwhelmingly blamed on temporary financial difficulties experienced

by clients. In one-fourth to one-fifth of the cases, these financial difficulties are specifically

associated with the client's inability to sell goods supplied by, or manufactured with goods

supplied by, the respondent. Respondents' answers suggest that, in some cases, the seller is

implicitly providing a warranty that the good will resell well. Family events are also invoked by

clients to excuse late payment, more so with traders than manufacturers. Unlike non-payment,

deliberate cheating is only cited by one firm as the reason for late payment. The client's travel or

leaving the business are seldom mentioned either. Mistakes and oversights are cited in a few

cases, particularly in connection with bounced checks. Whether these were genuine mistakes

10

remains questionable, as a few smiles and shrugs reminded us. But respondents readily accept the

excuse in exchange for prompt payment.

Among the manufacturing flrms in the sample, non-payment is more prevalent in the textile

and garment sector, a possible reflection of the economic difficulties that the industry is facing

as a result of structural adjustment and trade liberalization. Discussions with respondents indicate

that few public flrms or agencies pay earlier than a month after delivery; late payment is the rule,

a reflection of the flnancial difficulties experienced by the Ghanaian government. Late payment

and non-payment are also more common the closer flrms get to the [mal consumer: downstream

flrms, traders, and manufacturing flrms dealing directly with customers, like tailors, are more

affected than flrms dealing mostly with other flrms or traders. Half of payments problems (Table

3) happen with an individual consumer or a small flrm and in a third of the cases with a trader -­

often a small retailer or itinerant peddler. Payment problems are thus influenced by what happens

at the end of the manufacturing-wholesale-retail chain, probably because the need for risk sharing

is strongest among poor consumers and microenterprises starved of working capital.

The most likely course of action taken by respondents, particularly traders, when faced

with a client who has not paid is to wait for some time then start harassing clients to induce them

to pay (Table 1 and 2). Discussions with respondents indicate that they initially display

understanding when clients invoke plausible excuses to delay payment. As the delay lengthens,

however, they become more suspicious and increase their pressure. Direct bargaining is the

favored method of conflict resolution (Table 3). Letters are sent, repeated visits are made to the

work place or the home, insults are exchanged between respondent and client, screams are heard,

and third parties and messengers are involved. A large proportion of flrms, particularly among

traders, agree to negotiate a rescheduling of payments and to let the client pay in instalhnents. But

the boundary between voluntary rescheduling and coerced delay in collection is hard to draw

precisely.

Harassment and repeated visits, respondents argue, serve three purposes. First, they are

annoying and make the debtor want to flnd the money. Second, they increase the likelihood that

the respondent is there when the debtor comes into some money. For that reason, visits are'mostly

made on pay day or market day, or if the creditor is aware that the debtor collected from one of

his or her customers. Third, they enable the creditor to evaluate whether or not the client was hit

by a shock. This information can be used to infer the client's type and decide whether to continue

the relationship or not. Respondents only give up trying to get their money back either when they

have physically lost track of a recalcitrant client and no longer know where to flnd him or her,

11

or when it has become clear that they are unable to force the client to pay. The ability to impose

repayment thus depends both on the clients' financial ability to repay and on their continued

practice of business. Respondents appear at a loss trying to recoup a debt from clients who have

left their line of business and thus lost interest in the relationship EV(r, c), even if they hold other

assets, like a home.

The payment collection strategy used by surveyed firms seems to work well: in two-third

of the cases -- more for manufacturing firms, less for traders -- the dispute is resolved

satisfactorily and business is resumed (Table 3). This implies that the ability to renegotiate the

contract is implicitly present in most credit sales. But it imposes a serious debt collection burden

on the firms. Firms who deal mostly with public agencies, the worst payer of all according to

respondents, even have a full-time staff member entirely devoted to debt collection. Collection

costs alone could explain the existence of a large number of trade intermediaries (Bauer (1954)),

each unable to expand further because limited by its ability to monitor and collect payments from

customers.

Respondents who either have collected a substantial advance or have not yet delivered a

custom-made good -- e.g., some metal firms and many garment manufacturers -- constitute an

important exception: they hang onto their output until the customer comes to pick it up and pay.

This strategy is not always effective, however, although undelivered goods usually incorporate

materials and inputs that belong to the client. If it were not for the limited scope of this paper,

customized items raise specific contractual issues that are worth investigating in their own right.

The point to emphasize here is that custom-made items are hard to liquidate. Respondents may

prefer to wait for the client to show up, even late, than sell at a loss. Certain respondents are also

unsure about their right to resell the good even after a substantial delay in payment. But at least

the firm enjoys the psychological satisfaction that the client has not run away with the fruits of

their labor.

Exports are a special case. Exporters who received an irrevocable letter of credit from

their foreign buyer are seldom paid late since payment is automatic after presentation of transport

documents. Banks, however, are accused of delaying the transfer of international funds so as to

benefit from the accruing interest. In the case of standard letters of credit, the situation is different

since payment can be delayed if the client challenges the quality of the delivery. The four firms

in the sample that export some of their production invariably run into such problems. The absence

of SGS-like inspection for goods leaving Ghana makes it easy for foreign clients to reject goods

after delivery and to extort discounts from Ghanaian exporters. Exports to neighboring African

12

countries are also a source of difficulty. Respondents indicate that red tape is pervasive in spite

of the ECOW AS trade agreements, and that border duties are an opportunity for custom officers

and other officials to extract rents. For those who try to follow legal procedures, the extra cost

of paying taxes and bribes and of getting the required paperwork jeopardizes the profitability of

the transaction and makes payment to the Ghanaian exporter less likely. As a result, trade across

African borders is mostly informal and bypasses the institutional setup -- e.g., letter of credit, bill

of lading -- that governs international trade with the developed world. So doing,- it deprives firms

of legal protection against bad payers and poor quality supplies. Most respondents declare

avoiding direct import or export with neighboring countries.

Relations With Suppliers

Late and Non-Delivery by Suppliers

Firms were asked about late and non-delivery by suppliers. Their answers are summarized

in Table 4 and 5 respectively. Only fourteen firms out of fifty eight recall ever experiencing the

non-delivery of goods that had been ordered from a supplier (Table 4). There are many more

cases of late delivery than of non-delivery (Table 5): about half the surveyed firms report having

faced the problem in the past, and the frequency of reported cases is five times higher. In a third

to a half of the cases (Tables 4 and 5), partial or total payment had been made before delivery,

which means that respondents incurred losses beyond the inconvenience of a failed order.

Delivery problems are most frequent in the wood sectors. Competition with exports for

good quality timber, we were told, is a major explanation for these difficulties. Before trade

liberalization, lumber was implicitly subsidized as a result of the overvalued exchange rate. The

devaluation of the cedi has led to an increase in the domestic price for timber. To remain

competitive, domestic wood industries now rely on low quality timber, either rejects from exports

or timber harvested by small operators with inferior equipment. The supply of this lumber

category is particularly erratic. The food sector is also affected by late delivery problems, but the

average delay is comparatively short. In other sectors, the failure of foreign frrms to satisfy orders

is the major reason for non-delivery. Imports also account for an large proportion of late

deliveries with an average delay of 6 to 15 weeks. Public firms are notable for late delivery but

the delays involved are usually very short.

Reasons given for failed deliveries vary between industries (Table 4). In the wood and

metal sectors, non-deliveries result from difficulties faced by suppliers in fmding suitable lumber

and metal sheets and in the financial problems faced by some of them. In other sectors, the

13

inability to produce or to fmd suitable inputs is the major reason given. Suppliers to trading fInns

blame their inability to deliver mostly on insufficient capacity, the need to satisfy other customers

and on mistakes and oversights. In a couple of cases, non-delivery occurred following an

unexpected increase in the market price or the supplier's cost. Reasons given for late delivery are

list in Table 5. Most traders and many manufacturers attribute it to transportation hazards and the

inability of suppliers to satisfy all the demand. Equipment breakdown and the supplier's own

inability to secure essential inputs are next on the list and most frequently blamed for late delivery

in the wood and metal sectors. In the presence of frequent and unpredictable delays in production,

suppliers are unable to guarantee delivery on a certain date without holding inventories of fmished

products. Delays in delivery are thus a way of shifting production risk and a part of commercial

risk to the buyer. Discussions with respondents indicate that certain suppliers, particularly public

finns, sell at a low price with the implicit understanding that late deliveries are frequent and that

the burden of production risk and the cost of holding inventories are transfered onto buyers.

Sufficiently low prices induce buyers to put up with late delivery.

The action taken by respondent firms depends whether advance payment has been made

or not (Tables 4 and 5). When no advance payment was made, firms initially react by waiting or

sending an occasional reminder. If delays get too long, they cancel the order. Whenever payment

was already made, firms typically complain and harass their suppliers, sometimes successfully,

sometimes not. In the two cases in which non-delivery was attributed to drastic changes in the

opportunity cost to suppliers, respondents agreed to renegotiate the contract. Renegotiation is also

the normal outcome when only a small portion of the order has not been supplied; firms carry

over the unfulftlled portion of the contract to their next order. While traders usually prefer to wait

or cancel their order if the delay gets too long. manufacturing fInns are more likely to pursue

suppliers and insist on timely delivery. The reason is that manufacturing firms require inputs to

operate. Traders told us they often have alternative ways of using their working capital and can

afford to wait.

Firms facing frequent delivery problems indicated during interviews that they minimize

the impact on their production activities either by over-ordering, ordering early, building up

inventories, or securing supplies from other sources. Although effective, these strategies impose

a cost on the firm. Furthermore, they are not available to firms with insufficient working capital,

particularly microenterprises. Finns unable to stock inputs must stop production when deliveries

are delayed. Traders appear to serve as buffer between manufacturers and suppliers of raw

materials. Indeed, those who operate in industries where non-delivery is frequent face more such

14

cases per year than do manufacturing firms (Table 4). Holding buffer stocks of raw materials thus

appears as yet another important economic function assumed by African traders.

Deficient Quality of Inputs

Finns were also asked about deficient quality of inputs. Judging by the proportion of finns

affected, deficient quality is a common occurrence, particularly in the wood and food sectors

(Table 6). But it rarely affects more than a small portion of the quantities delivered. Whereas

imports are responsible for a large percentage of non- and late deliveries, they account for few

deficient quality cases. Respondents attribute this achievement to the inspection of every shipment

to Ghana by SGS, an independent Swiss company, at the port of origin. Yet, in spite of inspection

by SGS and of the detailed product specification that appears in letters of credit, a number of

foreign firms manage to deliver deficient inputs. One can only wonder at what would occur

without SGS inspection.

Deficient quality is usually blamed on suppliers' inadequate equipment or on their inability

to find inputs of good quality. In several cases, inadequate quality resulted from mistakes and

oversights, either by the supplier or, in the case of two tailors, by the respondent who purchased

the wrong input. One respondent felt he had been cheated by a supplier who had willfully

misrepresented the quality of the good delivered. Half the time, finns are in a position to assess

the quality of the goods delivered before finalizing payment. In this respect, manufacturing flIlllS

benefit from the fact that, unlike the traders interviewed in the sample, they often receive supplier

credit. The most frequent action taken by respondents when faced with deficient quality is to

return or exchange the goods. The second most frequent action is to negotiate a discount on the

next consignment. A few traders mention that insurance against deficient quality was built into

the contract, either by arranging an explicit insurance policy against damage in transportation, or

by supplying a few extra items to compensate for the possibility of defectives. The risk of

deficient quality is thus nearly always borne by the supplier. Buyers, however, assume part of the

cost of screening quality.

Most Recent Problem With Suppliers

Respondents were asked about their most recent problem with a supplier (Table 7). The

most commonly cited problem is deficient quality, followed by late delivery. Non-delivery comes

last. Traders are most affected by deficient quality and manufacturers by late delivery, but sample

sizes are too small to conclude that the difference is statistically significant. Manufacturing firms

15

have problems mostly with traders, and traders mostly with manufacturers, small and large. This

is consistent with the role of traders as intermediaries between manufacturing fIrms, and between

domestic fIrms and foreign suppliers. Foreign fIrms account for a number of litigious cases,

mostly in the metal and textile sectors. Public fIrms and agencies are cited as problematic

suppliers by the food industry.

The length of acquaintance between fIrms and their suppliers, 7.9 years on average, is

slightly longer than the average length of acquaintance with problematic suppliers, which is 6.1

years. Sample sizes are too small, however, to conclude whether the difference is significant. As

respondents emphasized throughout the interview and as is clear from the next section, few

problems are recorded with casual suppliers because firms do not take the chance of a problem

happening. Such transactions often are of the 'inspect-then-pay-cash-and-carry' type; they do not

involve delayed obligations that make breach of contract possible.

In three-fourth of the cases, direct bargaining with the supplier is used to solve the

problem. This is true for traders and manufacturers as well as across sectors. In the remaining

cases, the problem essentially resolves itself. The diffIculty is nearly always settled to the

satisfaction of the respondent and business continues with the supplier. The risk of late delivery

thus appears to be implicitly shared between buyer and supplier. Exceptions involve distant

foreign fIrms who have failed to supply or have delivered grossly inadequate products. Firms

. dealing with chronically late suppliers constitute a special case. They rarely fmd it useful to pester

the supplier and prefer to wait. Eventually, supplies are delivered and a new order is placed. But

the entire situation could hardly be described as satisfactory. Late and erratic deliveries place a

strain on the receiving fmn, forcing it to build up inventories or wait in line at the factory gate.

They may also delay the firm's production and damage its reputation vis-a-vis its own customers.

As argued earlier, lower prices often are what induce respondents to put up with poor contractual

performance.

Methods Firms Use to A void Problems With Clients

Respondents were asked what strategies they follow to avoid problems with their clients.

Multiple answers were allowed. The responses given emphasize ways of avoiding non-payment

and of screening trustworthy clients (Table 8). Respondents indicate that the most expedient way

of avoiding problems with clients is to insist on cash payment upon delivery. Credit should be

granted only to clients who have demonstrated in the past their ability and willingness to pay.

16

Finns indeed sell to 34 regular customers on average, but only 6.6 of them receive credit and 8.7

pay advances. These two fundamental, common sense principles account for most of the answers

given by respondent fIrms. Relying on legal sanctions and institutions is not perceived as a

practical way of preventing problems. Many fIrms keep simple records of transactions and ask

their clients to sign invoices when they get credit. But these records are used more to minimize

discussion on the reality of the debt than to ensure payment through legal recourse. Asking for

an advance payment is presented by some manufacturing fIrms -- but none of the traders -- as a

way of committing customers and reducing problems. Taking an advance also reduces exposure

to default. Some respondents argue that requesting a large advance is a way to make sure that the

client can afford the good, thereby implying that some customers would be glad to increase their

well-being but let their supplier worry about how to pay for it. One fIrm out of six -- one of three

in the textile and garment industry -- mentions keeping customers satisfIed as a way of avoiding

problems. Respon~ents note that clients use small defects as an excuse to delay payment or

renegotiate prices. Producing quality is a way of denying clients such excuses.

Firms take different attitudes after problems have arisen. Some. mostly manufacturers,

show flexibility and understanding when difficulties arise. This attitude is consistent with the

implicit sharing of risk. Others, mostly traders, suspend credit to bad payers and insist on the

settlement of old debt before granting new credit. Only one respondent insisted that he actively

maintains a reputation of being strict about payment deadlines. A woman trader explained the

dilemma facing a wholesaler whose retailer is not selling and is therefore unable to pay. If the

retailer is refused further credit and remains stuck with slow selling textiles, the woman said, ber

business will go down and the wholesaler may never recover her money. If, on the other band,

the retailer is given new, hot selling textiles, her business may regain impetus. In the process, the

slow moving textiles may fInd buyers and the wholesaler may recoup her money. This example

is illustration of the classical creditor's dilemma: throwing good money after bad may be the only

way to get both back (Gale and Hellwig (1985». Sharing business risk may be required to get

one's money back.

Granting credit only to clients who have paid in the past works well on average. But how

to identify trustworthy customers? One way is to rely on personal recommendation. Clients

recommended by trustworthy people are more likely to trustworthy themselves, respondents

argue. An implicit guarantee is often provided with the recommendation as well. Although

recommending people does not imply the obligation to cover their debts, the guarantor is sure to

be pestered by the creditor and asked to intervene should a problem arises. Furthermore the

17

reputation of the reconunender is tainted if the new client proves unreliable. For all these reasons,

people hesitate to endanger their reputation by reconunending a casual friend. As a result,

respondents say, the process of personal recommendation is relatively safe.

Non-business relations -- Le., relatives, neighbors, and church mates -- play little role in

identifying trustworthy clients. Several respondents declared that selling on credit to relatives and

neighbors amounts to signing the death warrant of the firm. Late payment and non-payment, they

argue, would be frequent as friendship and family ties get in the way of pressurizing clients. No

credit sales to relatives and family members were recorded in the survey. People prefer to

recommend relatives and friends to their suppliers for credit or preferential treatment. Some firms

use children of employees, friends, and neighbors as agents to sell their products -- in particular

ice-cream. These kids enjoy a good deal of independence in their operation and are fully

responsible for their sales. But they are totally dependent on the firm for their equipment and

supply and, in several cases, cannot operate without the firm's short term credit. Neighbors and

employees act as guarantor and means of pressurizing the boys if they misbehave.

Reputation per se, as distinct from interpersonal relations, plays little role in identifying

reliable clients. There seems to be no mechanism whereby information about clients'

trustworthiness is shared among firms other than direct reconunendation by common

acquaintances. When prompted directly, firms declare that they never bother communicating to

other firms information about untrustworthy customers. Sharing valuable information would

provide competitors with an undue advantage. In fact, several respondents appeared to relish the

idea that their competitors have to deal with the same dead beads by whom they had been burnt.

The only possible exception concerns Accra's women fishmongers, but their situation is somewhat

peculiar. They all belong to a closely knit neighborhood, they share the same ethnic baCkground,

their husbands go out to sea together, and they all sell in the same market. These women greet

bad payers on the main fish market with screams and shouts, thereby sharing infonnation instantly

in a simple but effective fashion. As a result; a bad client finds it difficult to remain in the fish

retail business since she cuts herself from the major source of supply, the fish market.

Some of the surveyed firms use more elaborate procedures to assess a client's credit

worthiness. One-fourth of the traders and one-sixth of the manufacturers actively screen

prospective trade credit recipients. The simplest method consists of inspecting the client's work

place. It is important, they say, to make sure that the client is what he or she claims to be.

Granting credit to a genuine business is a way of attracting a new regular customer, but letting

a hit and run speculator take goods without paying is calling for trouble. Simple inspection of the

18

work place also reveals whether goods are currently being produced and whether the client's

business is prosperous. Similarly, if the client is a flnal consumer or an itinerant trader, checking

his or her residence and spouse's work place provides information a1;x>ut that person's wealth and

ability to pay. More elaborate screening mechanisms are undertaken by a few flrms. A couple

respondents boast they could ask friends in the bank to run an informal credit check on one of

their customers, thereby revealing useful information about the existence and magnitude of lines

of credit, the frequency of bounced checks, and the regularity of deposits and withdrawals.

Whether such procedure was licit remains unclear, but both respondents insisted that their contacts

among bank staff were essential. Screening can also be done through customer accreditation. In

this process, prospective recipients of trade credit -- and people allowed to pay by check -­

provide information about their real and flnancial assets and possibly put down a deposit as

guarantee for payment. A more gradual approach to screening relies on learning progressively

about a client's qualities and business performance through repeated sales. Rare are the

respondents who are willing to extend trade credit to flrst time buyers. Only the couple

respondents who are able, thanks to special relations, to run detailed credit checks indicate that

they are willing to do so if their investigation is satisfactory.

In spite of all their sophistication, the above methods offer little protection against good

payers who, due to unforeseen circumstances or from their own volition, become bad payers.

There is the flsh lady who goes out with a bang, buying large quantities on credit and then

disappearing into thin air. There is the respected textile trader who retires, leaving large bills

unpaid. There is the customer who dies, leaving behind debts that are disavowed by his heirs.

There is the client who goes bankrupt, the client who moves to another city, and the client who

decides to take on another business. In all these cases, a good business relationship suddenly turns

sour, leaving behind unpaid bills. Several reported cases of non-payment loosely belong to this

category. Respondents were caught unaware. Whatever monitoring mechanism they had put in

place was fooled by their good-turned-mischievous client. When probed about these cases,

respondents declared that in spite of screening and monitoring they still expect some portion of

their trade loans to be defaulted as a regular risk of doing business.

With Suppliers

Respondents were also asked what strategies they follow to avoid problems with suppliers

(Table 9). Multiple answers were allowed. The results again conform with a no-nonsense attitude

toward business. More than a third of all the respondents -- nearly half the manufacturing frrms

19

-- state that the best way to avoid problems is to inspect goods before payment. Traders are less

likely to inspect goods than manufacturers, possibly because quality is less of a problem since they

do not use the goods to produce something. Several fInns mention third party inspection of goods

-- in particular inspeGtion of Ghanaian imports by SGS -- as a useful protection against defIcient

quality. A third of the respondents indicate that paying cash for goods delivered on the spot and

making sure that mutual obligations regarding payment and delivery are clearly defIned and

understood (although not necessarily put in writing) are efficient methods to prevent problems as

well.

Two-fIfth of the fInns declare that the best way to avoid problems is to deal with suppliers

with whom they have had satisfactory business in the past. Indeed, fInns deal with an average of

5.2 regular suppliers, 2.9 of whom on credit. They have known the suppliers who give them

credit for 7.9 years on average. Continuing business with reliable suppliers is thus the dominant

way of preventing problems. It is not a perfect insurance against contractual difficulties since a

portion of the supplier's production risk is transfered to buyers through late and non-<ielivery. But

it guarantees that, when problems arise, they are more easily resolved. Respondents cite their

willingness to show understanding when difficulties arise as a way of avoiding problems. This but

reflects their desire to maintain a positive business relationship with fIrms who are their major

providers of credit and sources of supply. In the case of traders, this desire is complemented by

deliberate efforts to cultivate one's image and relations through personal visits and business

lunches.

Firms are most likely to face serious contractual problems when they deal with unknown

suppliers. New manufacturing fU1l1S and fU1l1S reorienting their activities toward new sectors and

products, for instance as a result of structural adjustment and changes in relative prices, are most

at risk. Traders run into contractual problems because success in commerce, respondents tell us,

is based on the ability to take advantage of ever changing arbitrage opportunities, making it

necessary to transact with unknown fU1l1S. Finns screen potential suppliers in various ways. The

ftrst consists in relying on the reputation of a supplier or on the brand name of the product sold.

This method is cited by one respondent out of ten, mostly in the textile and garment industry. The

second consists in dealing with suppliers that one knows personally as a result of non-business

relations. Relatives, church mates, and neighbors enter in this category. The third consists in

dealing with suppliers who are recommended by people the respondent knows and trusts. Only

a couple of respondents cite each of the latter two approaches, mostly small finns and less than

ten percent of credit purchases take place with relatives. A few trading firms screening suppliers

20

in a more systematic fashion. using various techniques to directly assess their reliability -- credit

check, inspection of their premises, and formal process of accreditation.

Legal Institutions and Procedures

Surveyed ftrms make little use of legal institutions and procedures (Table 10). Ten firms

consulted a lawyer: six in relation with contracts with their suppliers, five regarding contracts with

their clients. Only one large trading firm ever sought a lawyer's advice in relation with both

suppliers and clients. Four of the six cases regarding suppliers have to do with imports. Only two

firms mention repeated occurrences, both traders. Most respondents fmd the assistance of a lawyer

useful and effective. One, however, emphasized that sending a lawyer's letter to his most

important customers had destroyed the relationship and led to his demise. Only four respondents

ever went to court with clients or suppliers, one of them several times. Two of the cases are still

pending in court, one of them in a foreign country. For the two firms that got judgement, the

outcome was favorable but they chose not to execute the judgement: a textile wholesaler had

second thoughts about throwing an elderly couple out of their home, and a large trading firm

hesitated to foreclose because it would have meant putting 500 people out of work and raising

political turmoil during an election year.

Three firms made use of informal arbitration. In one case, independent auditors resolved

a dispute between supplier and client by checking both firms' accounts. In another, a lumber

trader sought the mediation of the Loggers' Association. In the third, the respondent obtained the

mediation of local Committees for the Defense of the Revolution (CDR) in resolving disputes with

suppliers. He nevertheless apologized to us for involving politically charged paramilitary groups

in business matters. On at least two occasions, respondents sought the assistance of a Ghanaian

Embassy abroad. A Ghanaian firm managed to recover part of a debt from an Ivorian trader by

having the Ghanaian Embassy in Abidjan put pressure on the trader's spouse. In another case, a

Ghanaian importer sought legal advice from one of Ghana I s Embassies in Europe. Ghana being

a small player in Europe's international trade, the Embassy had too little clout to pressurize the

European supplier into compliance with the contract. Only four of the respondents, three of them

traders, ever brought to the police one of their dispute with a supplier or client. Two others

threatened to do so, but would have refrained if the client had called their bluff. Involving the

police in one's business matters is a tricky process. First, the police does not investigate

contractual matters; evidence has to be provided by the plaintiff. Second, the police provides its

services in exchange for a bribe. Who gives the highest bribe may gather the most support for his

21

cause. Most respondentS expressed a profound dislike for involving the police in their contractual

disputes.

Section 3. Lessons From the Survey

The survey provides evidence that is impressionnistic and needs to be confinned by other

studies.s It nevertheless provides valuable insights on contract enforcement problems in Ghana and

on how local finns have adapted to the situation. The lessons one can tentatively draw from the

study are summarized below.

Contract Enforcement and Repeated Interaction

Although cash-and-carry transactions are undertaken with anyone, transactions involving

delayed contractual obligations are used only with a small number of firms and consumers. The

reason appears to be that, for most business transactions in Ghana, the direct and indirect costs

of enforcement through courts are larger than the value of the transaction. The threat of taking

a debtor to court is seldom credible and P(r, e, C) often is zero. Fii:ms therefore prefer to conduct

business with people they know. In particular they refrain from selling large quantities on credit

to firms or individuals they know little about. On average, they have done business for 7.9 years

with the suppliers who give them credit, and for 6 years with the clients to whom they give credit.

What motivates firms to fulfill their contractual obligations, even if with some delay, is

the desire to continue profitable, long-tenn relationships and to maintain sources of supply and

demand. They pay their suppliers because they need more goods in the future. They deliver goods

on time to keep customers satisfied. The business relation itself EV{T, e) is the creditor's best

collateral. EV{r, e) is partly detennined by the debtor's business horizon. If the debtor is a

fly-by-night concern, EV{T, e)=O, and the likelihood of breach of contract is high. Ghanaian firms

faced with new prospective customers therefore focus their attention of establishing that the

customer is a bonafide enterprise, that is, one whose type Tis such that EV{r, e) is high. Little

effort seems to be made attempting to assess the honesty G{r, e) of potential clients or suppliers

independently from their interest in establishing a business relationship. Screening customers is

sometimes undertaken directly by visiting the customer's workshop or by asking questions to other

8See footnote 2.

22

traders. A few finns extend credit on this sole basis. Screening is also achieved indirectly by

observing someone's pattern of cash purchases over time. Losses due to non-payment by

customers or non-delivery by suppliers are part of a constant learning process about potential

trading partners. Discussions with respondents indicate that inexperienced finns are more prone

to credit recovery problems. Experienced firms incur painful experiences whenever they explore

new markets and sources of supply.

Few reputation mechanisms were brought to light in the Ghana survey; EW(r, e) appears

to be low. Infonnation about bad payers or unreliable suppliers is not shared among firms.

Business transactions are seldom initiated on the basis of reputation. Several respondents, when

asked whether they paid any attention to their clients' reputation among the business community,

indicated that gossip seldom is reliable. Only a couple of finns cited running bank credit checks

as a way of assessing the credit worthiness of potential customers. Otherwise, personnal

recommendation is the only way by which economic agents can capitalize on their good behavior

within a larger group. Instituting other ways of disseminating accurate information about credit

repayment perfonnance should enable finns who wish to do so to establish a reputation within a

larger group and thus help them deal in a business like fashion with a larger number of firms.

Flexible Contracts, Risk Sharing and Opportunistic Behavior

Ghanaian businesses display a high degree of contractual flexibility. The need for

flexibility, shared by businesses across the world (Williamson (1985), Stone, Levy, and Paredes

(1992». is probably accentuated by the low level of economic development in the country. All

respondents recognize that the respect of contractual tenns regarding consistent quality, rapid

delivery and timely payment is difficult. Markets for raw materials, intennediate goods,

specialized services, and capital equipment are thin or nonexistent. Alternative sources of supply

often do not exist. Whenever technical difficulties or shortages of imported goods arise, they

cannot easily be circumvented and tend to ripple through downstream economic activities (Steel

and Webster (1991), Little, Mazumdar and Page (1987), Cortes. Berry and Ishaq (1987». Final

consumers are mostly poor and vulnerable to economic shocks. These factors combine to create

delivery, payment, and quality problems. Most of the reasons invoked for contract noncompliance

involve the sharing of these various sources of risk between business parties. Deliveries and

payments are rescheduled and business relations continued in most cases.

The genuine need for contract flexibility nevertheless opens avenues for opportunistic

behavior. Debtors can delay payment by claiming they were hit by a large negative shock. Firms

23

can delay delivery by claiming they could not find suitable inputs. Because such claims are hard

to verify, respondents express the concern that contractual flexibility may be abused. They are

suspicious of excuses given and attempt to verify them whenever possible and convenient. The

most widely used strategy to discourage opportunistic claims is to harrass recalcitrant debtors and

suppliers. Harrassment institutes a penalty for false claims, as most people do not like to be

constantly reminded that they did not fulfill their obligations. It also enables creditors to observe

the business activities and consumption pattern of their debtors for evidence on their ability to

pay.

Several reported cases of non-payment involve clients who left the business. These cases

can be interpreted as situations in which the debtor initially had interest in preserving the business

relationship and behaved accordingly for some time, but eventually that interest was lost: a shock

realization e dra'stical1y reduced EV (r, e). Although such occurences could also be construed as

risk sharing (Zame (1993», they were typically not perceived as such by respondents. The

following story told by one respondent is a good illustration. A fish trader purchased a quantity

of fish on credit with the intention of selling it in various villages. Later, she discovered that the

fish was not selling well because farmers had had a bad year. She therefore decided to leave the

fish business altogether and to reorient her trading activities to textiles. To start a textile operation

she needed funds. She was currently unknown to textile suppliers and could only purchase goods

on a cash-and-carry basis. All her working capital was tied up in fish, which she did not sell well.

So the only way for her to start a new operation was to not pay for the fish she had bought on

credit. The sum she owed was not large enough to justify. court action. Since she was not

intending to reenter the fish business, she did not mind angering fishmongers. She thus carried

on with her plan, hoping never to be found. Such cases are hard to prevent. The only protection

respondent firms seek against occurrences like these is to make sure they know where to find

debtors in case they need to harass them.

Institutional Solutions

Ghanaian firms have found a response to enforcement problems which is to deal with a

handfull of suppliers and clients that they have known for years. This response, although effective

in enabling business to develop and firms to gain access to trade credit, leads to the fragmentation

of the economy into networks. It limits the range of commercial partners a finn may possibly deal

with in a businesslike fashion. Because the economic reach of Ghanaian firms is reduced, one

expects specialization and firm growth to be restricted. Local and foreign institutions have

24

emerged that partly redress the loss of efficiency due to fragmentation. Trade intermediation is

one of them. The function of traders is essentially to transcend economic fragmentation and to

build links between flrms that would not otherwise be able to do business with each other. An

Accra carpenter who needs wood, for instance, cannot, like his American counterpart, send a fax

to a distant lumber flrm and reasonably expect the wood to show up. He must rely on a trader

who has developed a personal relationship with that lumber flrm. The plethora of commercial

intermediaries that characterizes Ghana as well as many developing countries (Bauer (1954» can

thus be interpreted as a consequence of the high level of contract enforcement difficulties in an

undeveloped economy. The replacement of telephones, telexes and faxes by the ubiquitous trader

represent additional costs of doing business in Africa, however, because the time and capital

traders spend cultivating suppliers and clients must be compensated for (Geertz, Geertz, and

Rosen (1979». These costs are as much a consequence of underdevelopment as they contribute

-to it. Efforts to reduce the cost of trade intermediation must therefore be directed at improving

the enforcement of flexible contracts.

When trading with the developed world, Ghanaian importers and exporters rely on a

different set of institutions -- legal documents, banks, letter of credit, SGS, and insurance

companies -- all of foreign origin. The main function of these institutions is to ensure the respect

of contractual obligations. International banks, in particular, are relied on to ensure that payment

is made upon delivery. These institutions and intermediaries owe their existence to the high cost

of inspecting goods at the port of departure and of collecting payment in an alien country. The fact

that disputes remain frequent in spite of their presence is the best illustration of the universal

prevalence of contract enforcement problems. They nevertheless indicate that putting in place

institutions for the enforcement of contracts can make a difference. It is because these institutions

exist that Ghanaian flnns are able to deal with foreign flrms they know little about and with whom

the enforcement mechanisms on which they rely locally would fail because of the cost of

monitoring each other.

Policy Implications

The example of SGS and the letter of credit indicate that appropriate institutions for the

enforcement of international commercial contracts were able to expand the economic reach of

Ghanaian fmns. This section examines other possible institutional innovations that may be relevant

for Ghana and similar countries. Its purpose is to illustrate how concepts about contract

enforcement and information asymmetries can be applied to policy. It should only be construed

25

as indicative of the kind of policies or institutions that may be useful. Some of the suggestions that

follow may require changes in the law; some require that little used legal institutions be promoted;

others simply call for private initiatives, perhaps with government backing. In all cases, a careful

assessment of the legal implications of the recommendations made here is necessary. This can only

be done by Ghanaians themselves, possibly assisted from abroad.

Before we begin, three caveats must be kept in mind. First, even if contract enforcement

institutions are dramatically refonned. finns in Ghana like elsewhere will continue to conduct

most of their business on the basis of interpersonal relations and trust (Williamson (1985), Stone,

Levy and Paredes (1992»). The purpose of the suggestions made here is not to undermine existing

institutions but to add new options for transacting to existing ones. Second, contractual flexibility

is necessary in Ghana as in many other places and will continue to be. New institutions should not

aim at the rigid enforcement of all contracts thereby closing options for risk sharing among finns.

Third, collecting payment from insolvent firms and individuals is always problematic, irrespective

of contract enforcement institutions. Since many Ghanaians are poor and many fInns are small

and undercapitalized, insolvency is likely to continue creating payment problems. No new

institution can -- or should try to -- eliminate noncompliance altogether.

The focus of policy intervention is thus limited to enabling firms to conduct at least a

ponion of their business with other reliable firms and individuals with whom they have had no or

little prior business acquaintance. By extending the economic reach of fInnS, policy intervention

should improve economic efficiency and foster the development of a dynamic business . community. Success in this endeavor requires that opportunistic behavior be discouraged in

contractual matters, either by attaching a higher penalty to certain types of breach of contract, or

by making it easier for firms to assess the reliability of a potential client or supplier. To this we

now tum.

The fact that a couple of respondents are ready to extend credit on the basis of a bank

credit report suggests that establishing a system of credit rating for Ghanaian enterprises could

open access to trade credit for reliable firms.9 Disseminating infonnation about credit repayment

performance would assist finns in screening out unreliable business partners and enable good

payers to access credit by differentiating themselves from bad payers. Once credit rating

commonly used, trustworthy finns would find it in their interest to signal their reliability by

establishing an excellent track record. Firms with a good record, therefore, would be good credit

9Stone, Levy, and Paredes (1992) come to a similar conclusion regarding Brazil and Chile.

26

risks not only because they have demonstrated their ability to comply with strict payment

schedules, but also because they do not want to maintain their reputation. 10 Credit rating could

similarly be used by banks and fmancial institutions to assess the credit worthiness of their clients.

Thanks to credit rating, firms that cannot offer sufficient real security as collateral may still

qualify for bank credit through the discounting of bills and postdated checks.

The current court system in Ghana, although not particularly expensive nor inefficient,

remains too costly for most commercial cases. The value of commercial transactions rarely

justifies the cost and time involved in a legal suit in front of Ghana's regular court system. Setting

up small claims courts tailored on the American example may reduce the cost of legal proceedings

and help bring the court system closer to Ghanaian businesses. An alternative and perhaps

complementary option would be to favor private arbitration in general, particularly for small

cases. One could also envisage specialized commercial courts with simplified judicial and asset

recovery procedures .

. When faced with the breakdown of a relationship, a few firms in the sample sought help

by bribing members of the police or paramilitary groups. The police, however, has no authority

to seize property. All it can do is to threaten to detain or, perhaps, mistreat bad payers.

Alternative options exist that put state coercion at the service of expeditious debt recovery without

infringing on the debtor's human rights. A more liberal use by judges of the impounding of

accounts and moveable assets at the outset of court proceedings would discourage delaying tactics

by recalcitrant debtors. Ghanaian judges' concern for a certain conception of fairness seems to

currently stand in the way, but this issue deserves more investigation. The same idea could be

taken one step further by instituting a rapid, non-adversarial procedure to assist commercial

creditors. A special judge or legal officer could be instituted whose duty would be to impound

assets and accounts to serve clearly identifiable commercial debt instruments - e.g., postdated

checks, bills of exchange, and signed invoices.ll The ultimate objective of these measures,

however, is neither to replace face to face negotiations, nor to reduce contractual flexibility, but

IOSee Kreps, Milgrom, Roberts and Wilson (1982) for an theoretical application of this principle to a very different situation, that of chainstores facing potential entrants.

11 Let us call these legal officers bailiff in reference to the medieval officers administering justice at markets and fairs (Braudel (1986». Acts of the bailiff would be immediately executable but impounded assets and accounts would not be transferred to the creditor right away. The debtor would have a specified time to appeal the bailiff decision in a regular court. The debtor could choose to bring the matter in front of a small claims court (and thus incur no lawyer's fee) if such a court exists, or to settle out of court with the creditor. If the debtor did not react within the specified time, the assets would be auctioned to serve the creditor's legal claim.

27

to deter opportunistic behavior and discourage unnecessary delays. They all remain at the

discretion of the creditor. We expect most contractual disputes to continue being handled through

direct negotiation.

The system of international payments generally works well but it could be improved in a

few areas. Without third party inspection of their exports, Ghanaian exporters face the risk of

foreign firms disputing shipment on arrival, thereby delaying payment and forcing them into

granting discounts. To reduce this problem, third party inspection could be extented to Ghanaian

exports. 12 Import finance is also problematic but it falls beyond the scope of this paper. A third

area of possible improvement concerns trade between Ghana and its neighbors. Discussions with

respondents suggest that it is much easier and safer for a Ghanaian firm to trade with Europe than

with one of the neighboring countries. Effort by the Ghanaian goverrunent and the international

community to ease inter-African border procedures, reduce rent seeking, and assist the

enforcement of local import and export contracts could only boost trade between African

neighbors. Increased trade should help manufacturing firms gain access to a large enough market

and capture returns to scale.

12 A referee pointed out, however, that Ghanaian flrms may object to SGS inspection on export because it reduces opportunities for underinvoicing.

28

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.... ..

Discussion Papers

# '';

The Enforcement of Commercial Contracts in Ghana

Marcel Fafchamps

The views and interpretations expressed in this study are solely those of the authors. They do not necessarily represent the views of the World Bank or its member coun1rles and should not be attributed to the World Bank or its affiliated organizations.

T bl I N P a e . on- ayment b cr y lents . Total Traders Manuf.

Number of valid answers 52 13 39 Number of respondents citing problems 30 10 20 A verage number of cases per year 2.0 4.9 1.0 Time elapsed since last case, in days 426 245 517 Percentage of cases involving exports 7% 0% 10% Percentage of cases involving public flnns 7% 10% 5% Percentage of cases with full delivery 87% 100% 80% Percentage of cases with partial payment 47% 40% 50% Percentage cases involving bounced checks 3% 0% 5%

Percentage of cases in which the following reason was given for non-payment: Client faced personal problem or breakdown of equipment 7% 10% 5% Client was unable to sell 3% 10% 0010 CI ient was unable to collect payment from own customer 17% 20% 15% Client faced unspecified financial difficulties 13% 20% 10% Client had to travel 7% 0010 10% Client moved or left the business Client cheated Mistake or oversight by client or his staff Client challenged the quality of the good delivered Respondent could not tell

7% 27%

0% 3%

17%

0% 40% 0% 0% 0%

Percentage of cases in which the following action was taken by the respondent:

10% 20%

0% 5%

25%

Wait; do very little 23% 0% 35% Insist on fulfillment of contract (remind, harrass, sue) 63% 90% 50% Negotiate a rescheduling of payment 13% 10% 15%

Source; RPED Case Study

Table 2. Late Payment by Clients

Total Traders Manuf. Number of valid answers 50 12 38 Number of respondents citing problems 41 12 29 A verage number of cases per year 62 235 8 Average length of delay in payment 72 139 4S Percentage of cases involving exports 2% 0% 3% Percentage of cases involving public fmns l()olo 8% 10% Percentage of cases that occured after full delivery 90% 100% 87% Percentage of case involving partial pre-payment 14% 17% 13% Percentage of cases involving bounced checks 19% 25% 17%

Percentage of cases in which the following reason was aiven for late payment: Client faced personal problem or breakdown of equipment 10% 17% 7% Client was unable to sell 21% 25% 20% Client was unable to collect payment from own customer 2% 8% Client faced unspecified financial difficulties 38% 33% Client had to travel 7% 0% Client moved or left the business 0% 0% Client cheated 2% 8% Mistake or oversight by client or his staff 10% 8% Client challenged the quality of the good delivered 2% 0% Respondent could not tell 7% 0%

Percentage of cases in which the following action was taken by the respondent:

()O/o

40% 10% 0% 0%

10% 3%

10%

Wait; do very little 21 % 8% 27% Insist on fulfillment of contract (remind, harrass, sue) 38% 25% 43% Negotiate a rescheduling of payment 40% 67% 30%

Source: RPEO Case Study

Table 3 Most Recent Problem With Clients .

Total number of observations Number of respondents citing recent problems

Percentage of cases in which the most recent problem was: Non-payment of de lived item Late payment of delived item Late pickup or non-pickUp of custom order

Total 58 44

16% 77% 7%

Traders 13 12

25% 75%

0%

Percentage of cases in which the most recent problem was with a client who was:

Manuf. 45 32

13% 78% 9%

lndividual 25% 8% 31 % Small firm 23% 42% 16% Large ftrm (>100 employees) 7% 8% 6% Government agency 7% 8% 6% Trader 32% 25% 34% Foreign ftrm

Percentage of cases in which client was a relative Percentage of cases involving first sale to client Average nber of years of previous business with client Percentage of cases in which direct bargaining used Percentage of cases that were settled Percentage of cases in which respondent is satisfied Percentage of case resuming business with client

Source: RPED Case Study

5%

0% 27% 4.13 82% 63% 69% 67%

0%

0% 25% 2.11

100% 58% 64% 50%

6%

0% 28% 4.84 75% 66% 71% 74%

Table 4. Non-Delivery by Suppliers

Total Traders ManuC. Number of valid answers 55 13 42 Number of respondents citing problems 14 3 II A verage number of cases per year 1.6 3.5 1.0 Time elapsed since last case, in days 74 2S 87 Percentage of cases involving imports 29010 33% 27% Percentage of cases involving public fmns 7% 0% 9% Percentage of cases with full or partial payment 43% 67% 36% Percentage of cases with partial delivery 29% 67% 18%

Percentage of cases in which the following reason was 2iven for non-delivery Supplier faced equipment breakdown or was unable to produc 14% 0% 18% Supplier was unable to fmd goods or inputs 29% 0% 36% Supplier was in fmancial difficu Ities or leaving production 21 % 0% 27% Supplier had insufficient capacity to satisfy all customers 7% 33% 0% Mistake or oversight by supplier or his employees 7% 33% 0% Transportation hazard 7% 0% 9% Delay with processing papers or import documents 0% 0% 0% Price went or cost conditions changed dramatically 14% 33% 9% Supplier cheated or delayed willfully 0% 0% 0%

Percentage of cases in which the following action was taken by the respondent: Wait or do nothing 14% 0% 18% Insist on the fulfillment of the contract (complain, remind, etc) 29% 33% 27% Agree to renegotiate the contract (new order, carry over, etc) 29010 67% 18% Cancel order, ask for refund or compensation 290/0 0% 36%

Source: RPED Case Study

· .

T bl 5 Lat D r b S a e . e e Ivery y r upp lers

Total Traders Manuf. Number of valid answers 55 12 43 Number of respondents citing problems 28 6 22 A verage number of cases per year 7.3 6.7 7.4 A verage length of the delivery delay, in day 19 8 22 Percentage of cases involving imports 29% 33% 27% Percentage of cases with public fInns l8% 33% 14% Percentage of cases with payment before delivery 30% 50% 24%

Percentage of cases in which the following reason was given for late delivery: Supplier faced equipment breakdown or was unable to produc 21 % 17% 23% Supplier was unable to find goods or inputs 29% 33% 27% Supplier was in financial difficulties or leaving production 0% 0% 0% Supplier had insufficient capacity to satisfy all customers 36% 33% 36% Mistake or oversight by supplier or his employees 0% 0% 0% Transportation hazard 29% 50% 23% Delay with processing papers or import documents 7% 0% 9% Price went or cost conditions changed dramatically 0% 0% 0010 Supplier cheated or delayed willfully 4% 0% 5%

Percentage of cases in which the following action was taken by the respondent: Wait or do nothing 54% 67% 50% Insist on the fu1flllment of the contract (complain, remind, etc) 50010 33% 55% Agree to renegotiate the contract (new order, carry over, etc) 7% 0% 9% Cancel order, ask for refund or compensation 18% 33% 14%

Source: RPED Case Study

T bl 6 D a e . eficient Quality from Suppliers

Total Traders Number of valid answers 54 12 Percentage of firms with input quality problems 61% 9% A verage percentage of deficient inputs in delivery 3.0% 6.7% A verage number of cases of deficient delivery per year 3.0 0.3

. Percentage of cases involving imports 13% 11% Percentage of cases involving public firms 10% 11% Percentage of cases in which assess quality then pay 42% 33%

Percentage of cases in which the following reason for deficient quality was given: Supplier's equipment inadequate; normal factory defect 48% Supplier was unable to find good quality inputs 32% Supplier was in financial difficulties 0% Supplier has insufficient capacity 0% Mistake or oversight by supplier or his staff 10% Damage in transport 3% Damage occured as a result of delay in processing papers 3% Price went up or cost conditions changed 0% Supplier cheated or misrepresented quality willfully 16% Poor judgement by respondent or hislher staff 6%

Percentage of cases in which the following action was taken by respondent: Do noting; take a loss 26% Return or exchange 55% Negotiate discount on the next consignment 26% Compensation for defectives built into contract 6%

Source: RPED Case Study

56% 22% 0% 0% 0%

11% 11% 0%

11% 0%

33% 33% 11% 22%

ManuC. 42

22% 1.5%

4.1 14% 9%

45%

45% 36%

OOAl 0%

14% 00/0 0% 00/0

18% 9%

23% 64% 32%

00/0

T bl 7 M R a e . ost ecent P bl W' hS r ro em It upJ!uers

Total number of observations Number ofre~ondents citing recent problems

Percenta~e of cases in which the most recent problem was: Non-delivery by supplier Partial delivery by supplier Late delivery by supplier Deficient quality of goods or services supplied

Total 58 39

8% 3%

38% 51%

Traders 13 10

10% 0%

30% 60%

Manuf. 45 29

7% 3%

41% 48%

Percentage of cases in which tbe most recent problem occured with a supplier who was: Individual 0% 0% ()O/O Small firm 10% 20% 7% Large frrm (> 1 00 employees) 31 % 60% 21 % Government agency 10% 0% 14% Trader 3 1% 0% 41 % Foreign frrm 18% 20% 17%

Percentage of cases in which supplier was a relative Percentage of cases involving first purchase from supplier Average nber of years of previous business with supplier Percentage of cases in which direct bargaining used Percentage of cases that were settled Percentage of cases in which respondent satisfied Percentage of case resuming business with supplier

Source: RPED Case Study

5% 5% 6.1

74% 87% 83% 92%

0% 0% 4.1

80% 90% 90%

100%

7% 7% 6.8

72% 86% 81% 90%

Table 8. Methods Used to Avoid Problems With Suppliers

Total Traders Manur. Number of valid answers 53 13 40

Negotiate well defmed contract; give precise specifications 32% 31% 33% Inspect goods at delivery or before payment 38% 15% 45% Rely on third party inspection 8% 8% 8%

Deal with suppliers with whom had satisfactory business 34% 23% 38% Deal with suppliers who are non-business acquaintances 4% 8% 3% Deal with suppliers recommended by people you know 4% 0% 5% Deal with suppliers on basis of reputation and brand name 11% 15% 10% Rely on accreditation and direct inspection of suppliers 6% 15% 3%

Pay cash for goods delivered on the spot 36% 31% 38% Show understanding when difficulties arise 25% 31% 23% Cultivate good relations through visits and lunches 11% 23% 8% Vertical integration; long-term contracts 9% 8% 10% Other 4% 8% 3%

Source: RPED Case Study