Financial Constraints, Entry and Post-Entry Growth

1
Financial Constraints, Entry and Post-Entry
Growth
2
Motivation

• Firm dynamics is good for productivity growth
  because
• (1) New firms replace inefficient incumbents
• (2) It promotes efficiency-enhancing investment
  by incumbents
• Previous studies emphasize
• Adjustment costs induced by incumbent RD and
  advertizing
• Administrative costs of creating new firms
• Labor market regulations
• We investigate the role of financial
  constraints as barriers to entry, selection
  and post-entry growth

3
In this paper

• Effects of financial development on entry by firm
  size
• Effects of financial development on post-entry
  growth
• We use a harmonized firm-level cross country
  panel data set covering whole population of firms
  across 16 countries

4
Main findings

• FD has a strong positive impact on entry and
  post-entry growth of firms
• Impact is larger for small firms and may become
  negative for larger firms
• Robust to controlling for entry costs and labor
  market regulations
• Labor market regulations not significantly
  correlated with post-entry growth

5
Setup

• Two goods (partial equilibrium analysis)
• A numeraire that serves as a production and entry
  input
• A consumption good, at price p with a demand D(p)
• Each period t, there is a mass 1 of potential
  entrepreneurs in the consumption good market.
• An entrepreneur lives two periods. She is
  characterized by
• Initial capacity T1 (potential number of
  employees at date t)
• Long-term capacity T2 (potential number of
  employees at date t1)
• For simplicity, each employee produce one unit
  and wages equal zero.
• There is a large number of investors who can only
  assess the short-term capacity of potential
  entrepreneurs

6
Timing

• At time t (short term)
• Entrepreneurs decide whether to enter and pay a
  sunk cost b. They may borrow from investors.
• Entrepreneurs that enter produce and sell at
  equilibrium price p
• By investing K units of the numeraire good,
  entrepreneurs may expand their long-term capacity
  from T1 to (1aK)T1
• At time t1 (long term)
• Entrepreneurs produce and sell at equilibrium
  price p
• Entrepreneurs repay their debt

7
Solving the model without capacity expansion

• Initial capacity threshold ex post enforcement
  requires
• L lt µ pT0 where µ gt1
• Thus, initial capacity may not be lower than
• T0 b / µp
• ? The initial capacity threshold is decreasing
  in µp.
• Long term capacity threshold
• Profits must be higher than sunk entry costs
• T pT0 dpT1 gt b ? T1 gt T1 b / dp -
  T0 / d
• ? The long-term capacity threshold is
  decreasing with p.
• Price equilibrium D(p) S(µp, p)
• D(p) is decreasing in p and S(µp, p) is
  increasing in µp and p.

8
Impact of financial development

• Increase the ability to borrow (proportional to
  µp)
• ? Lowers the initial capacity threshold T0
• Lowers the equilibrium price p
• ? Increases the long-term capacity threshold T1
  
• Impact on entry and post-entry growth
• Increases entry by small firms
• (firms just below the previous short term
  capacity threshold T0)
• Decreases entry by large firms
• (firms just above the previous long-term
  capacity threshold T1)
• Increases post-entry growth because
• reduces size at entry increases growth
  potentials

9

• Figure 2 Impact on entry of an increase of
  financial development from µ0 to µ1

10
Solving the model with capacity expansion

• Higher financial development raises post-entry
  growth as it increases investment in capacity
  expansion while again lowering the short-term
  capacity threshold

11
Tested predictions

• Impact of financial development
• Increase entry by small firms
• Decrease entry by large firms
• Increase post-entry growth
• Even if we control by the size at entry
• Partial equilibrium analysis (ignoring economy
  wide effects through wage and exit options)

12
DATA (1)

• Coverage 16 countries (US, Western and Eastern
  Europe, Latin America) and 30 sectors, during
  1990s.
• Entry entry in the database
• Reflects real entry of all (1) firms
• Excludes one-year firms
• Entry rates are calculated by size categories
• s1 1-19 s2 20-49 s3 50-99 s4 100-499 s5
  500
• Post-entry growth employment growth of
  surviving firms
• Calculated as employment 6 years after entry
  among surviving firms compared with employment at
  entry

13
DATA (2)

• Indicators on financial development (outcome)
• Private credit / GDP
• Stock market capitalization / GDP
• Synthetic index FD (credit stock) / GDP
• We also consider regulatory variables

• Market
• Investor protection
• Public or Private registry
• (Doing Business 2006, Djankov McLiesh Shleifer
  2006)

• Bank
• Government ownership
• Entry requirements
• Regulation of activity
• Barriers to foreign entry
• (Barth Caprio Levine 2003, Micco, Panizza, Yañez
  2004, Gwartney, Lawson 2004)

14
Methodology

• Difference in difference approach (Rajan Zingales
  1998)
• ? We test whether financial development has a
  differential impact in sectors depending on
  external finance
• It allows including a variety of fixed effects
  (by country and sector)
• Other policy variables as controls
• Employment protection legislation (Frazer
  Institute)
• Interacted with the intensity of jobflows in US
  
• (source Bartelsman et al. database)
• Entry cost (Frazer Institute)
• Interacted with the turnover rates in US or
  with the growth potential of the sector (source
  STAN, OECD)

15
Estimated equations

• Entry (by country c, industry i, year t and size
  s)
• Post-entry growth (by country c and industry i)

16
(No Transcript)
17
(No Transcript)
18
(No Transcript)
19
(No Transcript)
20
(No Transcript)
21
Robustness checks

• Sensibility to the set of countries and sectors
• Controls for convergence effects (industry share)
• Interaction with potential growth (industry
  growth in US) instead of dependence in external
  finance
• Controls for incumbent size growth
• Post-entry growth at different durations
• Total employment growth of the cohort

22
EU countries versus US

• Lower competition and higher regulations in EU
  versus US banking
• Stock market capitalisation over GDP 0.64 for
  EU15 versus 1.17 for US in 2003
• Venture capital 0.5 of GDP in US versus less
  than 0.15 for Germany, France, Spain, Italy.