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

1. 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

2. 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?

3. 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)

4. 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)

5. 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.

6. 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

7. Figure 1: Distribution of Observations Across Geographic Areas

8. 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

9. Figure 2: Distribution of total firms, by country level income & year

10. Figure 4: Distribution of total firm observations, by age

11. Figure 5: Access to Letter of Credit by Age

12. Table 1a: Distribution of Working Capital Financing, by Age

13. Table 1b: Distribution of New Investment Financing, by Age

14. 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’

15. Percentage of firms using type of financing.

18. 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.

19. 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.

22. Table 5: Summary Statistics by Firm Age

23. Table 6: Is there a relationship between sources of finance and firm age?

24. 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

25. Figure 6a: Probability of Bank Financing Increases with Firm Age Probit regression of bank financing on age dummies and other control variables

26. Figure 6b: Probability of Informal Financing Decreases with Firm Age Probit regression of informal financing on age dummies and other control variables

27. Table 7A: How does Rule of Law affect the relationship between age and patterns of financing?

28. Table 7B: How does Credit Information effect the relationship between age and patterns of financing?

29. 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

30. Individual or Family as Largest Shareholder

31. 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.