Entrepreneurial Finance around the World: The Impact of the Business Environment on Financing Constraints
The Financing of Small - and Medium - Sized Firms OECD, Marche Region & University of Urbino "Carlo Bo" April 21-22, 2009
Larry Chavis, Kenan-Flagler Business School, UNC Chapel Hill
Leora Klapper, The World Bank Inessa Love, The World Bank
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
MENA 8%
IND SA 4% 7% AFR 15% EA 14% ECA 35%
LAC 17%
Institutional Variables
Low Income GDP per Capita Rule of Law Credit Information Index $398 -0.60 1.35 Lowermiddle Income $1,636 -0.49 2.79 Uppermiddle Income $5,086 0.23 4.58 High Income $16,939 1.07 4.94 Total $3,036 -0.27 2.91 Std. Dev. $4,504 0.64 2.11
• 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
Figure 2: Distribution of total firms, by country level income & year
40,000
Number of firm observations
Number of firm observations
25,000
30,000
20,000
15,000
20,000
10,000
10,000
5,000
0 High (8) Upper-Middle Lower-Middle (20) (37) Low (38)
0 1999 2000 2001 2002 2003 2004 2005 2006
Income level (number of countries)
Survey Year
Figure 4: Distribution of total firm observations, by age
Percentage of observations
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1 2 3 4 5 6 Age 7 8 9 10 11 12
Figure 5: Access to Letter of Credit by Age
0.6
Percentage of firms
0.5 0.4 0.3 0.2 0.1 0 1 2 3 4 5 6 7 Age 8 9 10 11 12 Age 13+
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 Foreign Banks Leasing Trade Credit Credit Cards Family & Friends Informal Sources Grants New Equity Other
8.1% 0.7% 0.3% 12.3% 0.4% 6.9% 1.4% 0.6% 6.0% 2.0%
7.9% 0.6% 0.5% 7.0% 0.3% 5.1% 1.6% 0.6% 5.3% 3.2%
9.4% 0.7% 0.5% 9.7% 0.4% 4.8% 1.1% 0.6% 5.3% 3.6%
10.2% 0.9% 0.6% 7.6% 0.4% 3.9% 0.8% 0.6% 4.7% 3.5%
10.5% 0.6% 0.8% 8.9% 0.4% 3.9% 0.9% 0.8% 4.7% 3.3%
10.9% 0.6% 0.8% 9.0% 0.4% 3.2% 0.7% 0.9% 4.4% 2.8%
15.1% 0.8% 0.7% 11.1% 0.4% 2.6% 0.6% 1.0% 3.5% 4.4%
12.0% 0.7% 0.7% 9.7% 0.4% 3.6% 0.9% 0.8% 4.3% 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 Local Banks Foreign Banks Leasing Trade Credit Credit Cards Family & Friends Informal Sources Grants New Equity Other 65.8% 8.4% 1.0% 1.3% 2.9% 0.1% 7.1% 3.1% 1.5% 6.3% 2.4% 65.6% 8.8% 0.9% 2.2% 2.9% 0.2% 5.8% 3.1% 1.1% 6.4% 3.2% 65.0% 11.2% 1.0% 2.6% 4.6% 0.3% 4.2% 1.1% 1.2% 5.3% 3.6% 66.2% 12.4% 1.2% 2.4% 2.8% 0.1% 3.7% 0.8% 1.3% 5.1% 4.0% 61.7% 13.8% 2.8% 2.9% 3.6% 0.2% 3.7% 0.8% 1.1% 5.4% 3.9% 64.0% 17.0% 0.9% 3.0% 2.9% 0.3% 2.9% 0.6% 1.1% 4.5% 2.9% 59.2% 19.2% 1.1% 3.2% 3.4% 0.2% 2.4% 0.5% 1.9% 3.8% 5.2% 62.4% 15.0% 1.2% 2.8% 3.4% 0.2% 3.6% 1.1% 1.5% 4.8% 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’
Table 2: Financing Patterns (working capital or new investment)
100.00% 90.00% 80.00% 70.00% 60.00% 50.00% 40.00%
30.00%
20.00%
10.00%
0.00% 1-2 Retained Earnings 3-4 Bank Finance 5-6 7-8 Operations Finance 9-10 11-12 13+ Equity Finance
Informal Finance
Percentage of firms using type of financing.
Table 3: Aggregated Bank Financing Patterns
50.00% 45.00% 40.00% 35.00% 30.00% 25.00%
20.00%
15.00% 10.00% 5.00% 0.00% 1-2 3-4 High 5-6 Upper-Middle 7-8 9-10 Lower-Middle Low 11-12 13+
Table 3: Aggregated Informal Financing Patterns
45.00% 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 1-2 3-4 High 5-6 Upper-Middle 7-8 9-10 Lower-Middle Low 11-12 13+
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 lowermiddle 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.
Aggregate Bank Financing Patterns (Europe)
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0% 1-2 3-4 High 5-6 Upper-Middle 7-8 Lower-Middle 9-10 Low 11-12 13+
Aggregate Informal Financing Patterns (Europe)
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0% 1-2 3-4 High 5-6 Upper-Middle 7-8 Lower-Middle 9-10 Low 11-12 13+
Table 5: Summary Statistics by Firm Age
Firm Firm age 5 age > 5 3.6 19.4 44% 35% 21% 38% 16% 32% 16% 39% 4% 1% 36% 44% 15% 5% 23% 40% 37% 24% 15% 32% 25% 55% 6% 4% 22% 46% 24% 8% *** *** *** *** *** *** *** *** *** *** *** *** *
Firm Age Micro Small Medium/Large Sole Proprietorship Partnership Owner Manager Exporter Audit Foreign Owned State Owned Low Income Lower Middle Upper Middle High Income
Table 6: Is there a relationship between sources of finance and firm age?
Line of Credit Ln Firm Age Micro Small Sole Proprietorship Partnership Other Legal Type Exporter 0.039 [0.001]*** -0.257 [0.000]*** -0.172 [0.000]*** -0.047 [0.252] -0.077 [0.003]*** -0.034 [0.212] 0.044 [0.001]*** 0.088 [0.000]*** -0.008 [0.823] -0.027 [0.655] 37,434 0.28 Bank Finance 0.039 [0.011]** -0.221 [0.000]*** -0.147 [0.000]*** -0.076 [0.000]*** -0.024 [0.412] -0.010 [0.686] 0.031 [0.059]* 0.046 [0.040]** 0.039 [0.553] -0.179 [0.000]*** 37,083 0.19 Operations Finance 0.012 [0.205] -0.093 [0.000]*** -0.009 [0.702] -0.037 [0.107] 0.021 [0.616] -0.020 [0.352] 0.017 [0.574] 0.001 [0.979] 0.054 [0.573] -0.044 [0.185] 37,083 0.17 Informal Finance -0.053 [0.000]*** 0.149 [0.000]*** 0.054 [0.012]** 0.072 [0.000]*** 0.021 [0.119] -0.030 [0.278] -0.018 [0.178] -0.023 [0.091]* -0.140 [0.000]*** -0.100 [0.000]*** 37,061 0.14
Audit
Foreign Owned State Owned Observations Pseudo R2
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
0.05
Coefficient Value
0 -0.05 -0.1 -0.15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Firm Age
• Probit regression of bank financing on age dummies and other control variables
Figure 6b: Probability of Informal Financing Decreases with Firm Age
0.45
Coefficient Value
0.35 0.25 0.15 0.05 -0.05 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Firm Age
• Probit regression of informal financing on age dummies and other control variables
Table 7A: How does Rule of Law affect the relationship between age and patterns of financing?
Ln Firm Age Bank Finance 0.037 0.029 0.033 [0.003]*** [0.014]** [0.025]** Informal Finance -0.051 -0.050 -0.050 [0.000]*** [0.000]*** [0.000]***
Rule of Law
0.087
[0.077]*
0.157
[0.005]***
-0.063
[0.007]***
-0.069
[0.031]**
Rule of Law * Ln Age Interaction
-0.029
[0.055]*
-0.030
[0.076]*
0.003
[0.786]
0.009
[0.404]
Country Fixed Effects
Observations Psuedo-R2
No
37,030 0.12
No
37,030 0.12
Yes
37,048 0.19
No
37,030 0.11
No
37,030 0.11
Yes
37,026 0.14
Table 7B: How does Credit Information effect the relationship between age and patterns of financing?
Bank Finance
Ln Firm Age 0.0365 [0.005]*** Credit Information 0.0055 [0.599] Credit Information * Ln Age Interaction Country Fixed Effects Observations Psuedo-R2 0.0881 [0.005]*** 0.0429 [0.054]* -0.0157 [0.026]** -0.0186 [0.046]** 0.1018 [0.018]** -0.0508 [0.000]*** -0.0007 [0.934]
Informal Finance
-0.0972 [0.003]*** -0.0331 [0.062]* 0.0146 [0.042]** 0.0143 [0.047]** -0.0981 [0.003]***
No 37,065 0.12
No 37,065 0.12
Yes 37,065 0.19
No 37,065 0.11
No 37,065 0.11
Yes 37,043 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 Owner Manager Female Principal Owner Age*Female Observations Pseudo R2 12,399 0.3 14,129 0.16 13,772 0.09 14,129 0.14 Line of Credit 0.037 [0.004]*** -0.027 [0.077]* -0.027 [0.308] Bank Finance 0.035 [0.004]*** 0.005 [0.783] -0.06 [0.081]* Operations Finance -0.011 [0.276] 0.008 [0.642] -0.027 [0.270] Informal Finance -0.041 [0.000]*** -0.002 [0.907] 0.04 [0.096]* Informal Finance -0.031 [0.000]*** -0.001 [0.926] 0.162 [0.065]* -0.046 [0.075]* 14,129 0.14
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.