Firm Size, Finance and Growth Thorsten Beck Asli Demirguc-Kunt Luc Laeven Ross Levine

Motivation What are the channels through which finance affects growth? Rajan/Zingales: access to external finance What is the effect of finance on firms of different sizes? Large firms depend more on financial markets and banks and benefit therefore more Financial development lowers fixed costs of financial intermediation, thus helps small firms relatively more Does financial development ease the growth constraints of small firms?

Related literature Rajan and Zingales (1998): industries more dependent on external finance grow faster in countries with better developed financial systems Gusio, Sapienza and Zingales (2004): Small firms benefit more from regional financial development than large firms across regions in Italy Beck, Demirguc-Kunt and Maksimovic (2005): financial development helps alleviate growth- constraining effect of financing obstacles more for small than for large firms

Technological firm size Industries have technological firm size distribution, thus a technologically determined share of small firms Since observed size distribution is distorted by policy and institutional factors, we need data from a country with relatively low frictions U.S. census data from 1992 Small firm share = Share of an industry ’ s work force in firms with less than 20 employees No significant correlation with external dependence (-0.04)

Firm size across industries

Methodology Growth = average annual growth of real value added of industry k in country i, averaged over FD = Claims of financial institutions on private sector relative to GDP Share = Initial share of industry i in 1980 in total manufacturing Sample: 36 industries across 44 countries OLS and IV

Financial development, small firm share and growth

Financial development, small firm share and growth - economic significance Small Firm Share: 25 th percentile: Spinning 75 th percentile: Furniture Private Credit: 25 th percentile: India 75 th percentile: Canada Furniture grows 1.4% faster than spinning in Canada than in India Average growth rate = 3.4%

Controlling for Additional Industry and Country Characteristics

Alternative measures of firm size distribution

Alternative small firm data

Alternative dependent variable

Robustness tests Additional industry characteristics: Asset composition (Claessens and Laeven, 2003) Growth opportunities (Fisman and Love, 2004) Additional country characteristics: GDP per capita, Openness, Human capital accumulation Alternative small firm cut-offs significant up to 100 employees Alternative data sources on small firm share: US Census 1997 UK Census data 1997 Alternative dependent variables: Growth over

Alternative indicators of financial development

The interaction of Small Firm Share and Liquid Liabilities Legal Efficiency Law and Order is positive and significant The interaction of Small Firm Share and Stock market turnover Accounting standards is insignificant

Conclusions Industries that rely more on small firms grow faster in countries with better developed financial intermediaries Additional channel through which finance affects growth: alleviating small firms ’ growth constraints Financial development has cross-industry distributional ramifications Financial development is an SME-friendly policy