Academic journal article International Journal of Entrepreneurship

The Moderating Effect of Banks on the Relationship between a Start-Up's Patent Performance and Loan Default Rate

Academic journal article International Journal of Entrepreneurship

The Moderating Effect of Banks on the Relationship between a Start-Up's Patent Performance and Loan Default Rate

Article excerpt

INTRODUCTION

High-technology based start-ups constantly strive to find a balance between leveraging what they know and investing in the future that may require different knowledge sets to advance their technologies (Benner & Tushman, 2003; March, 1991). For most start-ups, these technologies serve as essential factors to realize their entrepreneurial opportunities. In contrast, these start-ups are often unprofitable and lack the necessary resources so they must gain access to external resources in order to exploit their entrepreneurial opportunities (Beckman & Burton, 2008; Colombo & Grilli, 2005). Start-ups, however, may experience a "valley of death" transitional phase. In this growth stage, their technology is deemed promising yet without validated commercial potential (National Research Council, 2009) and they fail to access the direct financing sources (e.g. private equity). Since financial capital is essential to procure other types of resources, this lack of financial capital seriously hurts the start-up' growths and survivals.

To overcome such financial constraints, start-ups often access the lending market to continue exploiting their entrepreneurial opportunities. This lending market is defined as the entrepreneurial credit market. Indeed, banks have been a critical source of financing for start-ups, providing about 60% of debt financing to small businesses (Federal Reserve Bank of Atlanta, 2014). More specifically, start-ups have increasingly utilized the Small Business Administration (SBA) 7(a) loan program through banks. While the SBA 7(a) loan program provides a government-backed guarantee on the portion of loan amounts, banks are supposed to select qualified start-ups and take a portion of responsibility associated with a default.

The role of banks in the entrepreneurial credit market is justified because they possess the continuing ability to evaluate process, disburse, service and liquidate such loans (Dilger, 2013). A growing body of literature suggests that banks are able to overcome the asymmetric information problem by producing information about potential borrowers and using the information in the selection process. This notion, however, remains not fully explored because necessary information is often not readily available due to the nature of start-ups, which are young and do not have sufficient records about their operations, in the entrepreneurial credit market. Given these distinguishable characteristics of the entrepreneurial credit market, this notion should be revisited in a new framework that is consistent with the context of entrepreneurial credit market. This framework should be involved with how banks access a startup's private information to alleviate information asymmetry and avoid adverse selections, eventually enhancing their credit market performances. Since technological capability is often the most important resource for a start-up, my central question becomes how a start-up's technological capability impacts the default rate and what conditions under which banks affect the relationship between these two critical factors in the entrepreneurial credit market.

A stream of the literature I consider in this study is the literature on information asymmetry and adverse selection, which can be readily applied with the context of entrepreneurial credit market (Berger & Udell, 1995; Bhattacharya & Thakor, 1993; Boot, 2000; Fama, 1985; Fama & Malkiel, 1965; Freixas, 2005; Hodgman, 1961; Ongena & Smith, 2000; Petersen & Rajan, 1994; Rothschild & Stiglitz, 1976; Schenone, 2004). Start-ups often have private information about the value of their entrepreneurial opportunities. This private information allows start-ups to have superior information positions and distort uncertainty about their credit worthiness (Cole, 1998), leading to credit rationing equilibria (Stiglitz & Weiss, 1981) and invalidating other standard competitive market results (Broecker, 1990). …

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