Entering the export market entails incurring costs such as market research costs, market development and distribution channel development costs. A forward looking manager would weigh these sunk costs incurred during market entry, against the future stream of income. Therefore, entering the export market becomes a question of which firms have the ability to undertake this investment.
As per the Melitz model (2003), firms self select into the export industry if their productivity is high as it enables them to undertake the investment associated with new market entry. The Melitz model assumes only one factor of production; labor, whose supply is inelastic at the aggregate level. In this paper, I consider the other factor of production; capital, the availability of which might constrain a firm’s entry into the export market. In the presence of financial frictions, a firm’s investment decision will not be independent of its financing decision. Therefore, even a highly productive firm might be inhibited from entering the export market if it is constrained by its finances.