larry chavis, kenan-flagler business school, unc chapel hill leora klapper, the world bank inessa...
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Larry Chavis, Kenan-Flagler Business School, UNC Chapel Hill
Leora Klapper, The World Bank
Inessa Love, The World Bank
Entrepreneurial Finance around the World: The Impact of the Business Environment on Financing Constraints Entrepreneurial Finance around the World: The Impact of the Business Environment on Financing Constraints
The Financing of Small - and Medium - Sized FirmsOECD, Marche Region & University of Urbino "Carlo Bo"April 21-22, 2009
Financing, Entrepreneurship and Growth
• Entrepreneurship is vital for economic development (Schumpeter 1911, Hause and Du Rietz, 1984; Black and Strahan, 2002, Klapper, Laeven, and Rajan 2006)
• Access to external financing matters for private sector development and economic growth (Evans and Jovanovic 1989, Levine 2005)
• Our main questions:– What is the relationship between firm age and access
to external financing?
– Does the business environment impact this relationship between firm age and access to external financing?
What is the expected relationship between firm age and access to external financing?
• Mature firms have more internal funds, have more established relationships with lenders, and prefer bank to equity financing (Bulan and Yan, 2007) …
• …. While asymmetric information limits access to credit for new firms (Carpenter and Rondi, 2000)
• Higher financing constraints might reduce the likelihood of starting a business in emerging markets; e.g. Thailand (Paulson and Townsend, 2004)
What role does the business environment play in access to financing?
• In India, growth is often funded by informal sources (Allen et al. 2006)
• And in China, bank financing – and not informal sources – is associated with higher growth (Ayyagari et al. 2007)
• Protection of property rights benefits small firms more than large firms in providing access to financing (Beck, Demirguc-Kunt, and Maksimovic 2007)
• The mix of external financing, which influences firm growth, is affected by institutional development (Brown, Chavis and Klapper, 2008)
Preview of Results:
• Younger firms have:
• Less reliance on bank financing and more reliance on informal financing
• Better access to bank finance in countries with better rule of law
• The impact of the business environment:
• Credit information and rule of law have a differentially positive effect on the use of bank finance by young firms
• Credit information has a differentially negative effect on the use of informal finance by young firms
• Overall, our results suggest that improvements to the legal environment and credit information infrastructure are disproportionately beneficial for promoting access to formal finance by young firms.
Data
• World Bank Enterprise Surveys• 169 surveys across 103 countries
– Survey years 1999-2006
• 77,000 observations– 68,000 have financing data: 64,000 working
capital and 47,000 new investment– 43,500 have external financing– 60% manufacturing, 30% Services
• Supplemented with data on country level institutional environment
6
Figure 1: Distribution of Observations Across Geographic Areas
AFR15%
EA14%
ECA35%
LAC17%
MENA8%
SA7%
IND4%
Institutional Variables
• Overall Rule of Law designed to be mean of 0 and standard deviation of 1
• Credit Information is on a scale of 1 to 6
Low IncomeLower-middle Income
Upper-middle Income
High Income
Total Std. Dev.
GDP per Capita $398 $1,636 $5,086 $16,939 $3,036 $4,504Rule of Law -0.60 -0.49 0.23 1.07 -0.27 0.64Credit Information Index 1.35 2.79 4.58 4.94 2.91 2.11
Figure 2: Distribution of total firms, by country level income & year
0
10,000
20,000
30,000
40,000
High (8) Upper-Middle(20)
Lower-Middle(37)
Low (38)
Income level (number of countries)
Nu
mb
er o
f fi
rm o
bse
rvat
ion
s
0
5,000
10,000
15,000
20,000
25,000
1999 2000 2001 2002 2003 2004 2005 2006
Survey Year
Nu
mb
er o
f fi
rm o
bse
rvat
ion
s
Figure 4: Distribution of total firm observations, by age
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
1 2 3 4 5 6 7 8 9 10 11 12
Age
Per
cent
age
of o
bser
vatio
ns
Figure 5: Access to Letter of Credit by Age
0
0.1
0.2
0.3
0.4
0.5
0.6
1 2 3 4 5 6 7 8 9 10 11 12 Age13+
Age
Per
cen
tag
e o
f fi
rms
Table 1a: Distribution of Working Capital Financing, by Age
1-2 3-4 5-6 7-8 9-10 11-12 13+ Total
Panel A: Working Capital
Retained Earnings 61.4% 68.0% 63.9% 66.9% 65.2% 66.2% 59.6% 63.0%
Local Banks 8.1% 7.9% 9.4% 10.2% 10.5% 10.9% 15.1% 12.0%
Foreign Banks 0.7% 0.6% 0.7% 0.9% 0.6% 0.6% 0.8% 0.7%
Leasing 0.3% 0.5% 0.5% 0.6% 0.8% 0.8% 0.7% 0.7%
Trade Credit 12.3% 7.0% 9.7% 7.6% 8.9% 9.0% 11.1% 9.7%
Credit Cards 0.4% 0.3% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4%
Family & Friends 6.9% 5.1% 4.8% 3.9% 3.9% 3.2% 2.6% 3.6%
Informal Sources 1.4% 1.6% 1.1% 0.8% 0.9% 0.7% 0.6% 0.9%
Grants 0.6% 0.6% 0.6% 0.6% 0.8% 0.9% 1.0% 0.8%
New Equity 6.0% 5.3% 5.3% 4.7% 4.7% 4.4% 3.5% 4.3%
Other 2.0% 3.2% 3.6% 3.5% 3.3% 2.8% 4.4% 3.7%
Table 1b: Distribution of New Investment Financing, by Age
1-2 3-4 5-6 7-8 9-10 11-12 13+ Total
Panel B: New Investment
Retained Earnings 65.8% 65.6% 65.0% 66.2% 61.7% 64.0% 59.2% 62.4%
Local Banks 8.4% 8.8% 11.2% 12.4% 13.8% 17.0% 19.2% 15.0%
Foreign Banks 1.0% 0.9% 1.0% 1.2% 2.8% 0.9% 1.1% 1.2%
Leasing 1.3% 2.2% 2.6% 2.4% 2.9% 3.0% 3.2% 2.8%
Trade Credit 2.9% 2.9% 4.6% 2.8% 3.6% 2.9% 3.4% 3.4%
Credit Cards 0.1% 0.2% 0.3% 0.1% 0.2% 0.3% 0.2% 0.2%
Family & Friends 7.1% 5.8% 4.2% 3.7% 3.7% 2.9% 2.4% 3.6%
Informal Sources 3.1% 3.1% 1.1% 0.8% 0.8% 0.6% 0.5% 1.1%
Grants 1.5% 1.1% 1.2% 1.3% 1.1% 1.1% 1.9% 1.5%
New Equity 6.3% 6.4% 5.3% 5.1% 5.4% 4.5% 3.8% 4.8%
Other 2.4% 3.2% 3.6% 4.0% 3.9% 2.9% 5.2% 4.2%
Financing Categories
• Bank Finance– Local banks, foreign banks
• Operations Finance– Leasing, trade credit, credit cards
• Informal Finance– Informal sources (e.g. money lenders), friends and
family
• Equity Finance– New equity, grants, ‘other’
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
1-2 3-4 5-6 7-8 9-10 11-12 13+
Table 2: Financing Patterns (working capital or new investment)
Retained Earnings Bank Finance Operations Finance Informal Finance Equity Finance
Percentage of firms using type of financing.
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
1-2 3-4 5-6 7-8 9-10 11-12 13+
Table 3: Aggregated Bank Financing Patterns
High Upper-Middle Lower-Middle Low
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
1-2 3-4 5-6 7-8 9-10 11-12 13+
Table 3: Aggregated Informal Financing Patterns
High Upper-Middle Lower-Middle Low
European Countries by Income
• High (3,890)– Germany– Greece– Ireland– Portugal– Slovenia– Spain
• Upper-Middle (8,867)– Croatia – Czech Republic– Estonia– Hungary– Latvia– Lithuania*– Poland– Russia*– Slovak Republic– Turkey*
**Also surveyed as lower-middle income country.
European Countries by Income• Lower-Middle (13,437)
– Albania – Armenia**– Azerbaijan**– Belarus– Bosnia and Herzegovina– Bulgaria– Georgia– Kazakhstan– Macedonia– Montenegro– Romania– Serbia and Montenegro– Ukraine**
• Low (3,666)– Kyrgyz Republic– Moldova– Tajikistan– Uzbekistan
**Also surveyed as low income country.
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
1-2 3-4 5-6 7-8 9-10 11-12 13+
Aggregate Bank Financing Patterns (Europe)
High Upper-Middle Lower-Middle Low
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
1-2 3-4 5-6 7-8 9-10 11-12 13+
Aggregate Informal Financing Patterns (Europe)
High Upper-Middle Lower-Middle Low
Table 5: Summary Statistics by Firm Age
Firm Age 3.6 19.4
Micro 44% 23% ***
Small 35% 40% ***
Medium/Large 21% 37% ***
Sole Proprietorship 38% 24% ***
Partnership 16% 15% *
Owner Manager 32% 32%
Exporter 16% 25% ***
Audit 39% 55% ***
Foreign Owned 4% 6% ***
State Owned 1% 4% ***
Low Income 36% 22% ***
Lower Middle 44% 46% ***
Upper Middle 15% 24% ***
High Income 5% 8% ***
Firm age 5
Firm age > 5
Table 6: Is there a relationship between sources of finance and firm age?
Line of Credit Bank Finance OperationsFinance Informal Finance
Ln Firm Age 0.039 0.039 0.012 -0.053 [0.001]*** [0.011]** [0.205] [0.000]***Micro -0.257 -0.221 -0.093 0.149 [0.000]*** [0.000]*** [0.000]*** [0.000]***Small -0.172 -0.147 -0.009 0.054 [0.000]*** [0.000]*** [0.702] [0.012]**Sole Proprietorship -0.047 -0.076 -0.037 0.072 [0.252] [0.000]*** [0.107] [0.000]***
Partnership -0.077 -0.024 0.021 0.021 [0.003]*** [0.412] [0.616] [0.119]
Other Legal Type -0.034 -0.010 -0.020 -0.030 [0.212] [0.686] [0.352] [0.278]Exporter 0.044 0.031 0.017 -0.018 [0.001]*** [0.059]* [0.574] [0.178]Audit 0.088 0.046 0.001 -0.023 [0.000]*** [0.040]** [0.979] [0.091]*Foreign Owned -0.008 0.039 0.054 -0.140 [0.823] [0.553] [0.573] [0.000]***State Owned -0.027 -0.179 -0.044 -0.100 [0.655] [0.000]*** [0.185] [0.000]***Observations 37,434 37,083 37,083 37,061Pseudo R2 0.28 0.19 0.17 0.14
Economic Impact of Firm Age• 10 year old business is
• 9 percentage pts more likely to have bank financing (mean 19%) or a line of credit (mean 28%) than a 1 year old firm
• 12 percentage pts less likely to have informal financing (mean 14%) than a 1 year old firm
Figure 6a: Probability of Bank Financing Increases with Firm Age
• Probit regression of bank financing on age dummies and other control variables
-0.15
-0.1
-0.05
0
0.05
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Firm Age
Co
effi
cien
t V
alu
e
Figure 6b: Probability of Informal Financing Decreases with Firm Age
• Probit regression of informal financing on age dummies and other control variables
-0.05
0.05
0.15
0.25
0.35
0.45
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Firm Age
Co
effi
cien
t V
alu
e
Table 7A: How does Rule of Law affect the relationship between age and patterns of financing?
Bank Finance Informal Finance
Ln Firm Age 0.037 0.029 0.033 -0.051 -0.050 -0.050
[0.003]*** [0.014]** [0.025]** [0.000]*** [0.000]*** [0.000]***
Rule of Law 0.087 0.157 -0.063 -0.069[0.077]* [0.005]*** [0.007]*** [0.031]**
Rule of Law * Ln Age Interaction
-0.029 -0.030 0.003 0.009[0.055]* [0.076]* [0.786] [0.404]
Country Fixed Effects
No No Yes No No Yes
Observations 37,030 37,030 37,048 37,030 37,030 37,026
Psuedo-R2 0.12 0.12 0.19 0.11 0.11 0.14
Table 7B: How does Credit Information effect the relationship between age and patterns of financing?
Bank Finance Informal Finance
Ln Firm Age 0.0365 0.0881 0.1018 -0.0508 -0.0972 -0.0981
[0.005]*** [0.005]*** [0.018]** [0.000]*** [0.003]*** [0.003]***
Credit Information 0.0055 0.0429 -0.0007 -0.0331
[0.599] [0.054]* [0.934] [0.062]*
Credit Information * Ln Age Interaction
-0.0157 -0.0186 0.0146 0.0143
[0.026]** [0.046]** [0.042]** [0.047]**
Country Fixed Effects No No Yes No No Yes
Observations 37,065 37,065 37,065 37,065 37,065 37,043
Psuedo-R2 0.12 0.12 0.19 0.11 0.11 0.14
Robustness
• Percentage of type of financing as dependent variable
• Only surveys where minimum age of firms is one year
• Excluding transition countries• Excluding high and upper-middle income
countries• Single establishment firms only
Individual or Family as Largest Shareholder
Ln Firm Age 0.037 0.035 -0.011 -0.041 -0.031[0.004]*** [0.004]*** [0.276] [0.000]*** [0.000]***
Owner Manager -0.027 0.005 0.008 -0.002 -0.001[0.077]* [0.783] [0.642] [0.907] [0.926]
Female Principal Owner -0.027 -0.06 -0.027 0.04 0.162[0.308] [0.081]* [0.270] [0.096]* [0.065]*
Age*Female -0.046[0.075]*
Observations 12,399 14,129 13,772 14,129 14,129
Pseudo R2 0.3 0.16 0.09 0.14 0.14
Line of Credit Bank FinanceInformal Finance
Informal Finance
Operations Finance
Conclusions:
• Younger firms have less access to formal financing and rely more on informal sources, such as family & friends.
• The business environment matters!
• Young firms have relatively greater access to bank financing in countries with better Rule of Law and Credit Information.
• In countries with weak Credit information environments, young firms rely relatively more on informal finance.
• Overall, our results suggest that improvements to the legal environment and credit information infrastructure are disproportionately beneficial for promoting access to formal finance by young firms.