1. 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 The Financing of Small - and Medium - Sized Firms OECD, Marche Region & University of Urbino "Carlo Bo" April 21-22, 2009

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 6

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? Line of CreditBank Finance Operations Finance Informal Finance Ln Firm Age0.039 0.012-0.053 [0.001]***[0.011]**[0.205][0.000]*** Micro-0.257-0.221-0.0930.149 [0.000]*** Small-0.172-0.147-0.0090.054 [0.000]*** [0.702][0.012]** Sole Proprietorship-0.047-0.076-0.0370.072 [0.252][0.000]***[0.107][0.000]*** Partnership-0.077-0.0240.021 [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] Exporter0.0440.0310.017-0.018 [0.001]***[0.059]*[0.574][0.178] Audit0.0880.0460.001-0.023 [0.000]***[0.040]**[0.979][0.091]* Foreign Owned-0.0080.0390.054-0.140 [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]*** Observations37,43437,083 37,061 Pseudo R 2 0.280.190.170.14

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? Bank FinanceInformal Finance Ln Firm Age0.0370.0290.033-0.051-0.050 [0.003]***[0.014]**[0.025]**[0.000]*** Rule of Law0.0870.157-0.063-0.069 [0.077]*[0.005]***[0.007]***[0.031]** Rule of Law * Ln Age Interaction -0.029-0.0300.0030.009 [0.055]*[0.076]*[0.786][0.404] Country Fixed Effects No YesNo Yes Observations37,030 37,04837,030 37,026 Psuedo-R20.12 0.190.11 0.14

28. Table 7B: How does Credit Information effect the relationship between age and patterns of financing? Bank FinanceInformal Finance Ln Firm Age0.03650.08810.1018-0.0508-0.0972-0.0981 [0.005]*** [0.018]**[0.000]***[0.003]*** Credit Information0.00550.0429-0.0007-0.0331 [0.599][0.054]*[0.934][0.062]* Credit Information * Ln Age Interaction -0.0157-0.01860.01460.0143 [0.026]**[0.046]**[0.042]**[0.047]** Country Fixed Effects No YesNo Yes Observations37,065 37,043 Psuedo-R20.12 0.190.11 0.14

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.