The Role of Education and Experience in Small Firm Access to Bank Loans: Is There a Link?

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ABSTRACT

Prior research has revealed a link between human capital variables, specifically the educational level and prior experience of firm owners, and small firm survival and performance. This article examines the link between these same human capital variables and the ability of small firms to secure bank loans. Results indicate that firms with more highly educated owners were significantly more likely to have their most recent loan approved by a bank. Findings pertaining to the impact of prior owner experience were less conclusive, however.

INTRODUCTION

Small firms are a vibrant part of the United States economy. According to the U.S. Small Business Administration, there were 22.4 million small firms, defined as firms having fewer than 500 employees, in the U.S. in 2001 (SBA, Frequently Asked Questions, March 3, 2003). These firms represent 99 percent of all firms and produce 52 percent of Gross Domestic Product. They also employ approximately half of all private sector workers and provide the bulk of net new jobs (Small Business Share of Economic Growth, 2001).

In addition to serving as an engine of economic growth, small firms also provide a path to economic empowerment for previously disadvantaged groups (The New American Evolution, 1998). Women and members of minority groups are starting small businesses at a faster rate than white males (The State of Small Business, 2001). In some instances these entrepreneurs seek greater flexibility in their work schedules and the opportunity to do something they enjoy (McMahon & Stanger, 1995; Petty & Bygrave, 1993). In others, however, they seek the economic benefits associated with owning and operating a successful small firm.

For small firms, success is derived from a variety of factors including the state of the economy, the industry and its competition, and the product or service to be sold. Characteristics of the firm such as size, location, firm age, industry sector, and organizational status may contribute to survival and success. Financial capital, defined as the amount of capital that the entrepreneur can either raise or put into the firm himself, or herself is a key determinant.

Characteristics of the firm owner, particularly educational level and prior experience in the industry, may be important factors in firm performance. These characteristics are referred to as "human capital" as opposed to financial capital, and may be just as critical, particularly from the standpoint of potential investors. Education and experience equip the entrepreneur with skills and provide networks for customers, suppliers, and providers of capital. Prior research has also suggested that more highly educated and experienced firm owners have better critical thinking skills, more self-discipline, and a higher level of self-confidence (Cooper, GimenoGascon, &Woo 1994).

This article will examine the impact of owner education and experience on access to bank loans, a major source of financing for small firms. Unlike larger firms, small firms are not able to access the public debt and equity markets. Alternatively, they are heavily reliant on informal sources of capital, trade credit, and loans from financial institutions (Ang, 1991; Berger & Udell, 1998; Bitler, Robb, & Wolken, 2001; Cole & Wolken, 1995; Weinberg, 1994). Even in the case of financial institutions, however, small firms often experience difficulty in their attempts to borrow, because small firms are, by their very nature, riskier than large, well-established firms. Small firms have higher failure rates, they are undiversified in their products and geographic territories, and they often lack assets that can be used as collateral (Bates & Nucci, 1989; Scherr, Sugrue, & Ward, 1993). Thus, from a banker's perspective, many small firms are less than ideal borrowing candidates. If, however, higher levels of human capital contribute to a greater likelihood of firm success, firm owners with more education and experience should also have an easier time securing loans. …