Availability of credit to small and minority-owned businesses: Evidence from the 1993 National Survey of Small Business Finances

This article analyzes factors influencing the decisions of prospective lenders to extend credit to small and minority-owned businesses. Using data from a government survey of small businesses, the analysis reveals that prospective lenders (primarily commercial banks)are four times more likely to deny credit to firms owned by African-Americans than to firms owned by Non-Hispanic whites, and are twice as likely to deny credit to firms owned by Asian-Americans than to firms owned by Non-Hispanic whites. These differences in denial rates remain both statistically and economically significant, even after controlling for differences in the type and size of the prospective loan; in the age, experience, education, and creditworthiness of the firm’s primary owner; in the age, size, capital structure, profitability, organizational form, creditworthiness, and industry of the firm; and in the types and length of pre-existing relationships between the firm and its prospective lender. Interestingly, these differences in denial rates are significant only when the prospective lender is a commercial bank.bank; credit; discrimination; race; small business; SSBF

Banking consolidation and the availability of credit to small businesses

In this study, we use firm-level data from the 1993 National Survey of Small Business Finances to test the hypothesis that banking consolidation has reduced the availability of credit to small businesses. We find that banks in markets where mergers have occurred are more likely than other banks to deny credit to small business loan applicants. However, this relationship disappears after we control for characteristics of the small business firm and its principal owner, the economic environment of the market where the firm is located, and the financial condition of the prospective lender. Moreover, we find that one set of banks, those in the process of acquiring other banks, are less likely to deny credit to small businesses. These results suggest that consolidation in the banking industry may have enhanced rather than restricted the availability of credit to small businesses. However, the data reflect credit availability during 1991-94, and may not be representative of subsequent credit conditions. Nor does the analysis rule out possible changes in the terms of credit available to small businesses.acquisition; bank; bank merger; credit; merger; relationship; small business; SSBF; takeover

Legal origin, creditor protection and bank lending around the world

In this study, we test whether bankers make more loans when they enjoy superior creditor protection. We test these hypotheses using bank-level data from 35 developed countries and 113 developing countries over the period 2000-2006 and using a random-effects model that controls for bank heterogeneity. We find that bankers allocate a significantly larger portion of their assets to risky loans: (i) when they enjoy English common-law legal origin rather than French civil-law legal origin; (ii) when creditors’ rights are weaker; (iii) when their banks are larger; and (iv) when the largest shareholder has a lower percentage ownership. We also find that bankers in developing countries, but not in developed countries, allocate a significantly larger portion of their assets to risky loans when legal enforcement of creditor rights is more efficient. Overall, these results provide strong support for the theory of legal origin but provide only mixed support for the “power” theories of credit.banking, bank loans, bank risk-taking, creditor protection, creditors’ rights, emerging markets, investor protection, judicial enforcement, law and finance, legal origin, legal rights

What can we learn from privately held firms about executive compensation?

This study examines the determinants of CEO compensation using data from a nationally representative sample of privately held U.S. corporations. We find that: (i) the pay-size elasticity is much larger for privately held firms than for the publicly traded firms on which previous research has almost exclusively focused; (ii) executives at C-corporations are paid significantly more than executives at S-corporations; (iii) executive pay is inversely related to CEO ownership; (iv) executive pay is inversely related to leverage; and (v) executive pay is related to a number of CEO characteristics, including age, education and gender. Executive pay is inversely related to CEO age and positively related to educational attainment. Finally, female executives are paid significantly less than their male counterparts.Compensation; Organizational Form; Taxes; Ownership; Education; Gende

The role of commercial real estate investments in the banking crisis of 1985-92

This article examines the role of commercial real estate investments in the banking crisis of 1985-92, an unprecedented period during which more than 1,300 banks failed. Bank failures are fundamentally important because of the unique role played by financial institutions in the provision of business credit. We discover three striking features of banks failing during this period. First, commercial real estate was only a factor in the bank failures of 1988-92. Second, construction loans played a much larger role in bank failures than permanent loans, and the relationship is strongest with construction loans booked during 1983-1985. Third, other ex ante risk measures are systematically related to banking failure throughout the sample period. These results suggest that risk-seeking banks brought about their own demise and commercial real estate, especially construction lending, was one of the vehicles.bank; bank failure; commercial bank; commercial real estate; construction lending; real estate

A CAMEL rating's shelf life

How quickly do the CAMEL ratings regulators assign to banks during on-site examinations become "stale"? One measure of the information content of CAMEL ratings is their ability to discriminate between banks that will fail and those that will survive. To assess the accuracy of CAMEL ratings in predicting failure, Rebel Cole and Jeffery Gunther use as a benchmark an offsite monitoring system based on publicly available accounting data. Their findings suggest that, if a bank has not been examined for more than two quarters, off-site monitoring systems usually provide a more accurate indication of survivability than its CAMEL rating. The lower predictive accuracy for CAMEL ratings “older” than two quarters causes the overall accuracy of CAMEL ratings to fall substantially below that of off-site monitoring systems. The higher predictive accuracy of off-site systems derives from both their timeliness—an updated off-site rating is available for every bank in every quarter—and the accuracy of the financial data on which they are based. Cole and Gunther conclude that off-site monitoring systems should continue to play a prominent role in the supervisory process, as a complement to on-site examinations.bank; bank failure; CAMEL; CAMEL rating; commercial bank; offsite supervision

Bank credit, trade credit or no credit: Evidence from the Surveys of Small Business Finances

In this study, we use data from the SSBFs to provide new information about the use of credit by small businesses in the U.S. More specifically, we first analyze firms that do and do not use credit; and then analyze why some firms use trade credit while others use bank credit. We find that one in five small firms uses no credit, one in five uses trade credit only, one in five uses bank credit only, and two in five use both bank credit and trade credit. These results are consistent across the three SSBFs we examine—1993, 1998 and 2003. When compared to firms that use credit, we find that firms using no credit are significantly smaller, more profitable, more liquid and of better credit quality; but hold fewer tangible assets. We also find that firms using no credit are more likely to be found in the services industries and in the wholesale and retail-trade industries. In general, these findings are consistent with the pecking-order theory of firm capital structure. Firms that use trade credit are larger, more liquid, of worse credit quality, and less likely to be a firm that primarily provides services. Among firms that use trade credit, the amount used as a percentage of assets is positively related to liquidity and negatively related to credit quality and is lower at firms that primarily provide services. In general, these results are consistent with the financing-advantage theory of trade credit. Firms that use bank credit are larger, less profitable, less liquid and more opaque as measured by firm age, i.e., younger. Among firms that use bank credit, the amount used as a percentage of assets is positively related to firm liquidity and to firm opacity as measured by firm age. Again, these results are generally consistent with the pecking-order theory of capital structure, but with some notable exceptions. We contribute to the literature on the availability of credit in at least two important ways. First, we provide the first rigorous analysis of the differences between small U.S. firms that do and do not use credit. Second, for those small U.S. firms that do participate in the credit markets, we provide new evidence regarding factors that determine their use of trade credit and of bank credit, and whether these two types of credit are substitutes (Meltzer, 1960) or complements (Burkart and Ellingsen, 2004). Our evidence strongly suggests that they are complements.availability of credit; bank credit; capital structure; entrepreneurship; relationships; small business; SSBF; trade credit

How do firms choose legal form of organization?

In this study, we analyze the firm’s choice of legal form of organization (“LFO”). We find that only about one in three firms begins operations as a proprietorship, while almost as many begin as limited-liability companies and as corporations. Moreover, this distribution is remarkably stable over the first four years of the firm’s life. Fewer than one in ten firms changes LFO during its first four years. Those that do change LFO disproportionately move to a more complex form, primarily from proprietorship to a form with limited liability. Our analysis of the firm’s initial choice of LFO reveals that a firm is more likely to choose a more complex LFO when the firm is more complex as proxied by employment size, by offering more complex employee benefit plans, and by offering trade credit. A more complex initial LFO also is more likely when the firm is more highly levered and when its primary owner is more educated; but is less likely when the firm is more profitable, has more tangible assets, uses personal loans for firm financing and when its primary owner is female. Our analysis of the decision to change LFO finds that firms initially organized as LLCs or S-corporations are less likely, while Partnerships are more likely, to change LFO than are Proprietorships or C-corporations. Firms that increase employment or change location between a residence and rented/ purchased space, are more likely to change LFO, as are smaller and more profitable firms. Firms that experience a change in the number of owners (up or down), a decrease in the ownership of the primary owner or a change in industrial classification are more likely to change LFO. Of those firms changing LFO, the choice of a more complex LFO is more likely when the firm has changed location, experienced an increase in the number of owners or the ownership share of the primary owner, but is less likely when the firm has experienced a decrease in the number of owners.corporation; entrepreneurship; Kauffman Firm Survey; LLC; legal form of organization; organizational form; partnership; proprietorship; small business; start-up

Who needs credit and who gets credit? Evidence from the Surveys of Small Business Finances

In this study, we use data from the Federal Reserve’s 1993, 1998 and 2003 Surveys of Small Business Finances to classify small businesses into four groups based upon their credit needs and to model the credit allocation process into a sequence of three steps. First, do firms need credit? We classify those that do not as “non-borrowers;” these firms have received scant attention in the literature even though they account for more than half of all small firms. Second, do firms need credit but fail to apply because they feared being turned down? We classify such firms as “discouraged borrowers.” Like non-borrowers, discouraged borrowers have received little attention in the literature and often are pooled with firms who applied for, but were denied, credit. Discouraged borrowers outnumber firms that applied for, but were denied, credit by more than two to one. Third, do firms apply for credit, but get turned down? We classify such firms as “denied borrowers.” Finally, we classify firms that applied for, and were extended, credit as “approved borrowers.” Our results reveal strong and significant differences among each of these four groups of firms. Non-borrowers look very much like approved borrowers, consistent with the Pecking-Order Theory of capital structure. Discouraged borrowers resemble denied borrowers in many respects, but are significantly different along a number of dimensions. This finding calls into question the results from previous studies that have pooled together these two groups of firms in analyzing credit allocation. Finally, we find strong evidence that denied borrowers differ from approved borrowers across numerous characteristics, as previously documented in the literature. Of particular note, minority owned-firms, and especially Black-owned firms, were denied credit at a far higher rate than firms with owners who were white.availability of credit; capital structure; discrimination; entrepreneurship; small business; SSBF

What do we know about the capital structure of privately held firms? Evidence from the Surveys of Small Business Finance

The capital-structure decision is one of the most fundamental issues in corporate finance. Numerous studies have been conducted to test the two major competing theories of capital structure (Trade-Off Theory and Pecking-Order Theory), yet none of these studies has analyzed the capital-structure decisions of small, privately held U.S. firms, which constitute the vast majority of all U.S. business enterprises. In this study, we provide the first evidence on this important issue, utilizing data from four nationally representative surveys conducted by the Federal Reserve Board: the 1987, 1993, 1998 and 2003 Surveys of Small Business Finances (SSBF). We find that firm leverage as measured by the ratios of total loans to total assets and total liabilities to total assets is negatively related to firm size, age, profitability, liquidity and credit quality and is positively related to firm tangibility and limited liability. In addition, we find that firm leverage is an increasing function of both the number of banks and the number of non-bank financial institutions with which the firm has business relationships. Finally, we find no significant variations in firm leverage by race or ethnicity, but some evidence that femaleowned firms use less leverage. In general, these results are broadly supportive of the Pecking- Order Theory and inconsistent with the Trade-Off Theory