credit market competition and the nature of firms nicola cetorelli federal reserve bank of new york...
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Credit market competition and the nature of firms
Nicola CetorelliFederal Reserve Bank of New York
The research in this paper was conducted while the author was Special Sworn Status researcher of the U.S. Census Bureau at the NYC Census Research Data Center. Research results and conclusions expressed are those of the author and do not necessarily reflect the views of the Census Bureau. This paper has been screened to insure that no confidential data are revealed.
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What we know
Credit market competition important for firms’ life cycle dynamics
More credit competition leads to more entry, more growth, more small size firms, etc.
More competitive credit environment overall a good thing based on standard metrics
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Claim:
Credit conditions at time of founding leave imprinting on firms’ own nature (organizational structure, business plans,
managerial resources, …)
Effect is long-lasting
Impact on firms’ population dynamics is deep
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Conjecture
1. Non-competitive credit markets Financial capital hard to obtain Prospective entrepreneurs will select solid mix of
organizational structure, business plans, strategies, resources, …
2. Competitive credit markets Capital cheap and plenty, start up and folding costs lower Same entrepreneurs may select less solid package to start
a business Agents that in tougher environment would not undertake
entrepreneurship, might do so now.
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HIV-AIDS infection rates
2008 CDC report on HIV-AIDS infection rates among gay men Marked increase in infection rates among 13-24 age group Negligible and even negative rates for older age groups.
One explanation: “treatment optimism”. The successful introduction in the last decade of anti-retroviral therapies
Diminished fear of infection among younger individuals and increased likelihood of engaging in risky behavior.
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Impact on population dynamics : Pre-reform vintage firms may adapt
Pre-reform vintage firms may stay true to nature
Post-reform vintage firms may select into more fragile fundamentals
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This study
Use Census confidential data on universe of business establishments, 1975-2005
Use data on state-level deregulation removing interstate barriers to entry from out-of-state banks
Follow business establishments over life time and compared life statistics before and after the reform
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Findings
Pre-reform vintage firms have lower odds of mortality in post-reform years
Post-reform vintage firms intrinsically more fragile Despite better access to credit, worse odds of
mortality throughout entire life-cycle
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Environmental imprinting and structural inertia Well-developed concepts in organizational studies Core of organizational ecology field (Hannan and
Freeman, 1977, 1984, Carroll, 1984, Hannan, 2005). Evolution more from selection of newly founded firms than
from adaptation of pre-existing ones Structural inertia required to survive Arrow (1974): “…the very pursuit of efficiency in
organizations might lead to rigidity and unresponsiveness to change.”
Jovanovic (2001) has recent evidence on imprinting at founding and inertia
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Relation to literature Rajan and Zingales (2001): “Financial revolution” affects the
nature of firms.
Schoar (2008): Managerial style. “Recession CEOs” different over lifetime
Finance and the real economy: (Cetorelli and Gambera (2001), Black and Strahan (2002), Cetorelli (2004), Cetorelli and Strahan (2006), Bertrand, Schoar and Thesmar (2007), Kerr and Nanda (2007, WP)
Firm dynamics (Jovanovic, 1982, Hopenhayn, 1992, Albuquerque and Hopenhayn, 2004, Clementi and Hopenhayn, 2006, … )
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Identification
Conjecture is about innate fragility
Natural to focus on life’s chances
Estimation of hazard of mortality functions
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Identification
0 1 2 3 4 5 ... Age
Reform
Reform
ReformC
B
A
Compare hazard functions at each survival time (age)
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Identification
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1
0
( | ( ; ) ( | ( ; )
( | ; )
d d
jisy jisy
jisyjisy
S t X f t XL
S t X
1 2 ( )sy sy jisy jisyX Reform Reform Founding time Controls
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Results
Group A
Group B Group C
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Additional robustness tests Control for state-specific growth
Control for state and industry specific growth
“Vintage” dummies
Reset of regime switch from t to t + 3 (first few years after reform may actually get worse as banking industry reorganize)
Reset from t to t – 3 (interstate dereg final step of a process started with intrastate dereg)
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Alternative stories Can this evidence be explained with standard
theories of credit competition? No.
More competition, more credit. Predict all firms with better survival rates post-reform.
Petersen and Rajan (1995) story: young firms better off under monopoly banking, old firms better off under competitive banking. Predict crossing of hazard functions, and no differentiation by vintage (all young firms worse off after the reform)
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Alternative stories
Pre-reform vintage firms adapting to new environment? (Rajan and Zingales, 2001)
Implies pre-reform firms get weaker after the credit reform. There should be no difference with post-reform vintage firms.
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Alternative stories Bad banks instead of bad firms? No
More competition, banks lower standards and get less efficient at what they do. Implies no differential impact on firms based on vintage. Contrary to evidence. Banks got more efficient after reform (Stiroh and Strahan, 2002)
More competition, just new banks are worse and link up disproportionately with new firms. Contrary to evidence that banks entering in new markets are actually the more efficient ones (Evanoff and Ors, 2008).
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Searching for a new theory
In models of credit competition, population characteristics are part of the primitives.
Evidence here suggests a different approach.
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Conclusions Credit market reform has a deep impact on
firms’ life cycle dynamics Life expectancy is significantly altered Irrespective of vintage, odds of mortality are
lower after the reform But impact is heterogeneous within firms’
population. Firms of pre-reform vintages have a clear improvement in life’s chances, both in absolute terms and relative to firms of post-reform vintages
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Conclusions No natural life ending point for firms. Reform
may determine a progressive aging of population
May be all for the better: reform allows good firms from pre-reform vintages to thrive in conditions of more capital availability
It allows more Googles to be born (in a broader ocean of “would-be-but-should-not-really-be” entrepreneurs)
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Conclusions Broader point: Connection with path
dependence theories and institutional economics.
Problems with standard prescription of adopting institutional environment of developed economies.
Evolutionary approach followed here suggests complex impact of institutional reforms.
Initial conditions matter and development paths may not be replicable.