Academic journal article International Journal of Business

Credit Gap in Small Businesses: Some New Evidence

Academic journal article International Journal of Business

Credit Gap in Small Businesses: Some New Evidence

Article excerpt

I. INTRODUCTION

A growing body of empirical literature on small business lending suggests that credit constraint affects a significant proportion of small businesses; yet there is no estimate on the magnitude of this constraint. (1) The primary purpose of this paper is to estimate the magnitude of this credit constraint or credit gap (defined as the difference between the observed and the desired level of debt). Ideally measuring the credit gap involves identifying credit-constrained borrowers--i.e., borrowers that did not apply for a loan, fearing denial of application; firms that were unable to acquire the amount for which they applied; and small businesses that do not have credit in their balance sheets. Such data is rarely available for small businesses. Fortunately, data from the National Survey of Small Business Finances (NSSBF, 1988-1989 and 1993) provide direct evidence on credit-constrained firms, i.e., firms that did not apply for a loan fearing denial and firms that were unable to acquire the amount for which they applied--specifically questions J53 and J12 of the survey.

In theory, a significant credit gap is expected for small businesses due to acute information asymmetry between borrowers and lenders. Under information asymmetries, the excess demand for credit is partly due to the fact that lenders are unable to identify (and charge higher rates to) high-risk borrowers (Stiglitz and Weiss (1981)). In equilibrium, lenders will resort to rationing credit than use the interest rate as a market-clearing device (i.e., charge the less creditworthy borrowers higher rates of interest to compensate for the credit risk). Petersen and Rajan (1995) describe how initial asymmetric information creates adverse selection and moral hazard problems in which banks charge high rates initially and reduce rates in later periods after borrower types have been revealed. While anecdotal evidence on the severity of credit constraint among small business periodically surfaces in business press and policy discussions, evidence on the magnitude of this gap is nonexistent, mostly due to the absence of appropriate data. (2) Our results indicate that on average, credit-constrained small businesses desire 20 percent more debt. While there is extensive empirical work on measuring the credit gap for households, to the best of our knowledge we provide the first evidence on the magnitude of credit gap at the firm level for small businesses (see Hayashi (1985), Jappelli (1990), Duca and Rosenthal (1993), and Cox and Jappelli (1993)) for empirical evidence on credit gap for households). Our study extends the liquidity constraint literature on households and on relationship lending to small business finances.

Our empirical work highlights the importance of the selection biases inherent in quantifying desired debt. Any attempt to estimate the desired debt requires identifying a subsample of firms that have positive debt and are unconstrained in the credit market. Extending the econometric findings to all small businesses, however, requires that we control for differences between firms that are credit constrained and those that are unconstrained, and firms that have debt and those that have no debt. (3) Our estimates of sample selection term coefficients confirm that the subsample is indeed nonrandom, that unobserved factors which increase the probability of holding debt also increase the demand for desired debt, and that unobserved factors which increase the probability of being credit constrained reduce the demand for desired debt.

Finally, we provide evidence on how credit gap varies by firm characteristics. For example, manufacturing, wholesale, and service firms experience the largest credit gap, and utilities, insurance and mining firms appear to be unconstrained. We find that firms that employ between 50-99 employees have a larger credit gap than those that employ 100-499 employees. Similarly, C-corporations and S-corporations experience a greater credit gap than proprietary and partnership businesses. …

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