Larry Chavis, Kenan-Flagler Business School, UNC Chapel Hill Leora Klapper, The World Bank Inessa...

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.