INITIAL CAPITAL CONSTRAINTS HINDER ENTREPRENEURIAL VENTURE PERFORMANCE: AN EMPIRICAL ANALYSIS

Transcription

1 INITIAL CAPITAL CONSTRAINTS HINDER ENTREPRENEURIAL VENTURE PERFORMANCE: AN EMPIRICAL ANALYSIS MIRJAM VAN PRAAG CESIFO WORKING PAPER NO. 887 CATEGORY 4: LABOUR MARKETS MARCH 2003 PRESENTED AT CESIFO CONFERENCE ON VENTURE CAPITAL, ENTREPRENEURSHIP, AND PUBLIC POLICY, NOVEMBER 2002 An electronc verson of the paper may be downloaded from the SSRN webste: from the CESfo webste:

2 CESfo Workng Paper No. 887 INITIAL CAPITAL CONSTRAINTS HINDER ENTREPRENEURIAL VENTURE PERFORMANCE: AN EMPIRICAL ANALYSIS Abstract A novel method s appled to evaluate the effect of captal constrants on entrepreneural performance on a panel of 1,000 Dutch entrepreneurs. We fnd that ntal captal constrants hnder entrepreneurs n ther performance, even when we control for varous human captal and other factors that mght affect both performance and credt scorng outcomes. We use a drect ndvdual ndcator varable for ntal captal constrants. Prevous research wth the same objectve used ndrect ndcators of wealth, nhertances or wndfall gans, where t remans unknown whether the entrepreneur ndeed suffered from captal constrants. Ths drawback s not attached to our (nether perfect) approach so that polcy mplcatons wll become more evdent. Keywords: entrepreneurshp, small busness founders, success, venture performance, wealth/captal/borrowng constrant. JEL Code: G3, J2, L2. Mrjam van Praag Unversty of Amsterdam Faculty of Economcs Roetersstraat WB Amsterdam The Netherlands vanpraag@fee.uva.nl Ths manuscrpt s based on jont work wth Nels Bosma and Gerrt de Wt. I am thankful for ther contrbutons. Ths verson of the paper has largely benefted from the contrbuton by the partcpants n the CESfo conference Venture Captal, Entrepreneurshp, and Publc Polcy.

3 1. INTRODUCTION The observaton of resource spendng by governmental nsttutons for the sake of ncreasng numbers of hgher qualfed entrepreneurs s explaned by the socal beneft pertanng to entrepreneural endeavor that far exceed the entrepreneur s prvate beneft. The populaton of entrepreneurs s held accountable for searchng proft opportuntes through the ntroducton of new products, the mplementaton of lower cost producton processes, or through the tappng of new markets. By dong so, they play an undenable mportant role n creatng employment and economc growth. Another explanatory factor of ths observaton s the perceved exstence of undesrable mpedments to the supply of entrepreneurs. These factors therefore also explan the (academc) research actvty focusng on the number and performance of entrepreneurs and the factors hnderng these. A lack of captal or wealth s one of these factors. It s the focus of ths study. The objectve of ths paper s to answer the queston: To what extent s the performance of a small busness founder s entrepreneural venture, once started, affected by the experence of ntal captal constrants? And, what part of the effect on performance can be attrbuted to a real captal constrant, lack of opportunty to make approprate nvestments at the rght moments, and what part of the effect mght be explaned by spurous factors that both affect access to captal and performance drectly, such as screenng based on perceved abltes? The dstncton between these two types of factors s crucal snce polcy mplcatons dverge. In the frst case supplyng more captal, one way or the other, to entrepreneurs who are hndered to follow the optmal nvestment scheme would mprove performance. In the second case, t wll not because the captal constrant tself s not the bndng restrcton, but the factors underlyng t that affect performance. Much (emprcal) research effort has been put nto measurng the effect of captal constrants on the selecton of ndvduals nto entrepreneural postons (Evans and Jovanovc, 1989; Evans and Leghton, 1989; De Wt 1993; Holtz-Eakn et al., 1994b; Van Praag and Van Ophem, 1995; Lndh and Ohlsson, 1996; Blanchflower and Oswald, 1998; Dunn and Holtz-Eakn, 2000). The general concluson from ths type of research s that captal constrants bnd: a sgnfcant proporton of ndvduals wllng to enter the entrepreneural populaton s hampered by a lack of suffcent 2

4 captal. Blanchflower and Oswald (1998) present survey evdence that many employees would prefer to be self-employed, thereby ndcatng the exstence of mpedments at large. They also show that self-employed appear to be much more (work-) satsfed than are ther wage-workng counterparts, though the latter earn sgnfcantly hgher and more secured ncomes (Hamlton, 2000). Blanchflower and Oswald provde evdence that the sgnfcant mpedments to entrepreneurshp as ndcated by these results are n 50% of cases due to lack of captal. Captal markets are no doubt not effcent nor market clearng for the segment of new frms. (Fazzar, 1988). Personal savngs and loans from frends and relatves s by far the largest source of captal n newly started frms (as appears from our data and from Evans and Jovanovc, 1989, Blanchflower and Oswald, 1998). The common theoretcal explanaton for credt ratonng vs a vs newly founded frms s a severe lack of observable and verfable nformaton about the entrepreneur s type, her plans and the rskness assocated wth these plans. Moreover, the entrepreneur, fnancng her venture by means of borrowed captal, mght have ntentons conflctng wth these of the suppler of the loan. The asymmetry of nformaton on the entrepreneur s type and behavor wll potentally lead to agency problems: adverse selecton and moral hazard. (LeRoy and Sngell, 1987; Boadway et al., 1998; De Meza and Webb, 2000). The foresght of these problems prevents the start of a sgnfcant proporton of ventures. A negatve correlaton results between access to captal and entrepreneurshp entry. Research effort has also been devoted, though to a lesser extent, to measurng the correlaton between access to captal and entrepreneurshp performance once the stage of startup has been successfully completed (Fazzar et al, 1988; Evans and Jovanovc, 1989; Bates 1990, Cooper et al. 1994; Holtz-Eakn et al., 1994a; Cressy, 1996; Lndh and Ohlsson, 1996; Van Praag, 2002). Ths paper ams to contrbute to ths category of research. What happens to some common measures of performance when an entrepreneur has nsuffcent captal to reach the optmal nvestment level or the optmal tmng of nvestments? Fnancal captal constrants mght prevent entrepreneurs from creatng buffers aganst random shocks, thereby affectng the tmng of nvestments n an unfavorable way. Moreover, captal constrants mght debar entrepreneurs from the pursut of more captal-ntensve strateges. Especally the more able entrepreneurs mght be hndered n ths way, as captal and ablty are complementary resources for entrepreneurs. (Cf. Boadway 1998, De Meza and Webb, 3

5 2000, Evans and Jovanovc, 1989). Research n ths area has been performed by means of varous emprcal methods, all wth ther specfc data requrements, advantages and, unfortunately, drawbacks. Secton 2 summarzes and categorzes the research base measurng the extent to whch entrepreneurs performance s hndered by captal constrants. Secton 3 then elaborates on our method, ts contrbuton and ts weaknesses. We employ a selfreported measure of havng experenced bndng captal constrants n the frst year after the start of the venture and we relate ths to varous performance measures of the venture: survval, proft, and labor demand. The emprcal analyss s based on a representatve panel survey amongst almost 1,000 new busness founders n the Netherlands n the years We use these new busness founders as the emprcal equvalent of entrepreneurs. In order to measure the effect of captal constrants on the frm s performance due to the mpossblty of an optmal nvestment scheme correctly, the effect of our self-reported measure on performance should be corrected for varous factors turnng up n the lterature. Frst of all the screenng of captal supplers based on human and socal captal factors should be taken nto account. Moreover, unobserved heterogenety on whch redlnng mght be based s to be consdered. Fnally, tme constrants and the motvaton to perform by the entrepreneur are consdered too. Our unconventonally rch database enables these correctons. After havng dscussed how we approach these ssues n secton 3, we dscuss the dataset n secton 4. Secton 5 s devoted to the estmaton results and secton 6 concludes: Captal constrants affect performance sgnfcantly. 2. LITERATURE: POSITIONING AND OVERVIEW A lvely theoretcal debate has exsted about the relatonshp between access to captal and nvestment decsons of entrepreneurs, ever snce entrepreneurshp has become a topc of study. The frst stream of thought assumes captal markets to be perfect. External funds provde a perfect substtute for nternal captal n ths full nformaton case. An entrepreneur s fnancal condtons are rrelevant to nvestment: nvestment decsons are ndependent of whether one needs to pay the opportunty cost of captal ownershp, or the nterest rate of borrowng money. Proponents of ths vew can be traced back to Rchard Cantllon (1755) who was the earlest scholar of whom we know that he pad consderable attenton to the entrepreneur. He mplctly 4

6 assumed perfect(ly accessble) captal markets. Later classc nfluental economsts agreeng wth ths vew were Schumpeter (1934;1911) and Krzner (1973). The second stream of research n entrepreneurshp assumes less than perfect captal markets due to the exstence of mperfect and asymmetrc nformaton. The latter makes t very costly and sometmes even mpossble for provders of external fnance to evaluate the qualty of an entrepreneur s nvestment opportuntes. Ths mght debar (some) entrepreneurs from suffcent access to external captal. As a consequence, nternal and external captal sources are not perfectly substtutable. Ths vew has a hstory n economc thought of entrepreneurshp, too. The performance of the entrepreneur n the Classcal and Neoclasscal theores of Say (1971;1803) and Marshall (1930;1890) respectvely s hndered by a lack of own captal snce borrowed captal requres a reputaton (Say) or a rsk premum (Marshall). Knght (1971; 1921) held the same vew: nvestment decsons may depend on captal ownershp. Interestngly, before ths debate reganed nterest n the entrepreneurshp research socety n the late 1980 s, the same debate took place among researchers actve n the area of fnance and the study of nvestment at large (all company szes ncluded) n the late 1950 s and early 1960 s. As Fazzar et al. (1988) adequately summarze, especally the work of Meyer and Kuh (1957) emphaszed the mportance of fnancal consderatons n busness nvestment. Ths work ntated other contrbutons to such nternal funds theores of nvestment n the late 50 s and early 60 s. However, most research snce the mddle 1960 s has solated real frm (nvestment) decsons from purely fnancng factors. Modglan and Mller (1958) provded the theoretcal bass for ths second school of thought. Ther key nsght was that a frm s fnancal structure (read: entrepreneur s own wealth) would not affect ts market value (read: the entrepreneur s frm performance) under certan condtons. Appled to a frm s nvestment decsons, ths fndng by Modglan and Mller provded a foundaton for the neoclasscal theory of nvestment n whch frms are assumed to face a cost of captal, set n securtes markets that does not depend on the frm s partcular fnancal structure. Fazzar (1988) establshes convncng emprcal evdence for the exstence of a captal constrant, especally n the small frm case: access to external (borrowed) captal s dffcult or at least more costly than s nvestment by means of nternal captal. 1 1 Jensen and Mecklng (1976) had already put the Modglan Mller result nto the perspectve of asymmetrc nformaton. 5

7 The contnuaton of the debate n the entrepreneurshp research area, startng n the late 1980s, was largely emprcal. Please note that most emprcal research, ncludng our own, s based on the vew, as expressed by De Meza and Webb (2000) that asymmetrc nformaton apples at least to the type of entrepreneur (hdden type problem potentally leadng to adverse selecton) but may extend to the behavor of the entrepreneur (hdden acton problem potentally leadng to moral hazard). Furthermore, to prevent adverse selecton n the credt market, the pont of departure s not credt ratonng n response to the hdden type problem but redlnng or screenng nstead. Redlnng, screenng, or credt scorng, as appled n almost all real lfe cases, (De Meza and Webb 2000) nvolves supplers of money to use some selecton procedures based on a set of ndcator varables for the expected performance and rskness of entrepreneurs and ther projects. Those falng to score suffcently hgh on the crtera used are dened credt for whatever nterest rate they mght be wllng to pay. As a consequence, several ndcators of entrepreneurshp potental performance such as educaton and experence mght moreover turn out to be ndcators of access to captal (Bates, 1990; Scherr et al. 1993). Ths clarfes part of the dscusson below as to whether human (sometmes also socal) captal varables have been ncluded nto the emprcal models. To dscrmnate between the full nformaton and asymmetrc nformaton case, several categores of emprcal research have been performed. 2 An overvew s gven n Table 1. Relatonshp between assets and performance Evans and Jovanovc (EJ, 1989) test the extent to whch wealth constrants are bndng for entrepreneurs n the US. They relate the sze of famly assets to earnngs from the venture. They thereby test the mplcaton emergng from ther model that the correlaton between entrepreneural earnngs and ntal assets s postve snce wealther people wll have started busnesses wth more effcent captal levels. Condtonal on the values of some common human captal varables, ther reduced form estmates ndeed support a postve correlaton between ntal assets and earnngs. Cooper et al. ((CGW)1994) fnd the same postve correlaton between ntal assets and performance (survval and growth) of new ventures n The US. Ther result s 2 The same categorzaton mght be appled to research nto the relatonshp between the probablty of becomng an entrepreneur and access to captal. At least all approaches dscussed here have been 6

8 obtaned whle controllng for a rch set of human captal varables. Van Praag (2002) also relates fnancal varables,.e. assets and a dummy for home ownershp (frequently used as collateral), to survval of young entrepreneurs n the Unted States. The effect of these varables on the hazard out of entrepreneurshp s nsgnfcant. Van Praag uses a rch dataset too. Cressy (1996) explctly ams at testng the hypothess that the postve relatonshp between assets and survval generally found s spurous as a result of the underlyng effect of human captal on both asset accumulaton and survval. Hs emprcal result on a sample of Brtsh entrepreneurs supports ths hypothess. He attrbutes hs (superor) result to the avalablty of a rch dataset. Hs dataset s, however, certanly not rcher than s Coopers et al (1994). He concludes that provson of fnance s demand drven. Entrepreneurs self-select for funds on the bass of ther human captal: more talented entrepreneurs would demand more loans. Ths concluson contradcts most other conclusons from ths emprcal approach. Taylor (1999) estmates the effect of a rch set of potental determnants of the hazard out of self-employment, also for a sample of Brtsh entrepreneurs. One of the varables ncluded was a dummy ndcatng whether the respondent had receved nterest or dvdend payments exceedng 100 n a year pror to the start. Ths varable s nterpreted as an ndcator of asset ownershp. Its negatve effect on the hazard ndcates a postve effect on survval. Several general dsadvantages are attached to ths method. Frst of all, the possblty of obtanng external fnance remans unconsdered: t s assumed that the external route to obtan fnance s totally naccessble. Secondly, a monotone relatonshp s assumed between assets and performance, whle n realty t mght well be the case that up to a certan pont more access to captal mght help n enhancng performance, but enough s enough. Ths possble dscontnuty n the relatonshp s not taken nto account n ths approach. A thrd drawback of the method n general s that famly assets mght well be the result of the entrepreneur s earnng power : wthout bndng captal constrants, a correlaton could stll exst between assets and performance because of the entrepreneur s ablty affectng both quanttes. A fourth drawback, fnally, s that assets n general are badly reported n ndvdual survey research and therefore unrelable fgures, plagued wth measurement error. appled to the analyss of that research queston. 7

9 Table 1 Emprcal evdence of condtonal Corr(access to captal, frm performance)>0 Lack of access to captal measure /Performance measure Assets Inhertance Wndfall gans Earnngs EJ: + HJR: + Survval CGW:+; T:+; vp:0; HJR: + LO: + C:0 Growth CGW: + CGW: Coopers, Gmenogascon, and Woo (1994); C: Cressy (1996); EJ: Evans and Jovanovc (1989); HJR: Holtz-Eakn, Joulfaan, and Rosen (1994); LO: Lndh and Ohlsson (1996); T: Taylor (1999); vp: Van Praag (2002). 3 Relatonshp between nhertance recept and performance As was noted already, one of the major drawbacks of the approach of merely relatng assets, as a measure of access to captal, to new venture performance s the possble endogenety of ths measure. An nterestng alternatve mght be the recept of an nhertance. Blanchflower and Oswald (1998) noted the partcular appeal of such a varable: The recept of an nhertance s about as close to a natural experment as one s lkely to get n ths area, whch reduces potental endogenety problems. 4 Holtz-Eakn et al. (HJR, 1994a) were the frst to estmate the relatonshp of ths nhertance varable wth frm performance nstead of entry. They fnd a postve effect of recevng an nhertance on frm survval and earnngs n the Unted States. Ths nnovatve approach however only solves the thrd of the four drawbacks attached to the frst approach. One better than that, f not appled n an adequate fashon, an addtonal dsadvantage s evoked by the nhertance approach. Dunn and Holtz-Eakn (2000) analyzng transtons nto self-employment formulate ther fndng as: We fnd that young men s own fnancal assets exert a statstcally sgnfcant but quanttatvely modest effect on the transton to self-employment. In contrast, the captal of parents exerts a large nfluence. Parents strongest effect runs not through fnancal means, but rather through human captal,.e. the ntergeneratonal correlaton n self-employment. 5 3 Bates (1990) s excluded from the lterature overvew because he has unfortunately not been able to establsh the condtonal correlaton of nterest due to problems of multcollnearty. 4 Blanchflower and Oswald ntroduced ths approach n ther 1990 NBER workng paper verson of ther 1998 artcle. 5 However, HJR seem to have dealt wth ths ssue n a neat way: by controllng for () whether the nhertance donor s an entrepreneur too and () a measure of frm performance pror to the recept of the nhertance. 8

10 Relatonshp between wndfall gans and performance Lndh and Ohlsson (1996) estmate the effect of wndfall gans on the probablty of beng self-employed on a sample of Swedsh ndvduals. They thereby assess the effect of ths unque varable on some hybrd combnaton of the transton nto selfemployment and survval. 6 They consder wndfall gans as a dummy varable ndcatng whether people have ever won n lotteres as well as personal and spousal nhertances. They fnd sgnfcant effects on self-employment of both nhertances and lottery przes. However, upon ncluson of addtonal control varables (specfc and general human captal) the sgnfcant effect of nhertance recepts vanshes whereas the effect of lottery przes remans sgnfcant. Ths supports the fndng by Dunn and Holtz-Eakn (2000) about the ntergeneratonal correlaton of entrepreneurshp. The wndfall gans approach, as ngenous as t s, does not solve the majorty of the drawbacks assocated wth the frst approach, though t somehow solves the problem of endogenety. 7 The contrbuton and drawback of our approach are set out n the sequel. 3. ANALYTICAL FRAMEWORK Theory Consder the entrepreneural performance measure gross recepts, as n Holtz- Eakn et al. (1994) and n lne wth Evans and Jovanovc (1989): (1) P = θ f(k ) ε where θ s ndvdual s ablty or busness acumen as an entrepreneur, f(.) s a producton functon wth one nput, captal (k ), and ε s a random factor to the producton process. Indvduals know ther ablty, unlke the analyst or banker who observes an ndcator functon of ablty, ~ θ only. Ablty vares across ndvduals. It s assumed that ε has mean 1 and fnte varance and that f(0)>0: the frm can produce output even n the absence of any nputs, other than the entrepreneur s ndvdual busness acumen. The professonal servces ndustry s an example n whch ths s concevable. 6 See Van Praag 2002 for a formalzaton of the relatonshp between beng, becomng and survval as an entrepreneur. 9

11 A s defned as the value of the ndvdual s personal assets, hence A -k s the sum of money on whch the entrepreneur earns captal ncome at rate r. By defnton, k - A s the amount of captal fnanced by borrowng. The (rsk neutral) entrepreneur maxmzes total ncome: (2) y = θ f(k ) ε + r(a -k ) The optmal nvestment level of captal nto the producton process of the entrepreneur s venture s therefore defned by: (3) θ f (k * ) = r Hence, * k s an ncreasng functon of θ: entrepreneural ablty and captal are complementary factors of producton; more talented entrepreneurs run larger scale frms. We assume that A s a non-decreasng functon of θ : entrepreneural ablty s an ndcator for general earnng power from whch assets mght have resulted. The relatonshp between entrepreneural ablty and the amount of money that one wants to borrow n the money market at rate r, * k - A, s therefore ambguous. Access by ndvdual entrepreneurs to the most desrable amount of external captal, l * = k A 0 at prce r s constraned by the factor β, where 0 β 1. β = 1 represents the fully constraned entrepreneur, unable to obtan a sngle addtonal euro of external captal. β = 0 represents the unconstraned. The amount of external captal obtaned s ( 1 β ) l = 1 β ) (A k ) for all entrepreneurs. The value of ( β depends on borrowng power, whch s dependent n turn on collateral and ~ θ. The central queston of our analyss s to what extent β creates performance losses,.e. the effect of β on the expected (constraned) performance: * * * (4) P = θ f ( k β ( k A )) = θ f ( A + (1 β )( k A )) The formula shows that a hgher value of β would create, f any, more (absolute) damage to a hgh ablty entrepreneur than to a low ablty entrepreneur. Ths effect should not be mxed up wth the dea that β tself wll usually be hgher for low ablty entrepreneurs than for hgh ablty entrepreneurs. In order to get rd of the 7 Though both partcpaton n a lottery and selecton nto entrepreneurshp are sgnfcantly related to rsk atttude and therefore to each other (See Cramer, Hartog, Jonker, and Van Praag, 2002) 10

12 ntrudng effect of ablty on the relatonshp between absolute performance and captal constrants, we consder relatve performance n the sequel: (5) log P * = logθ + log f ( k β ( k * A )) Equatons 4 and 5 mmedately show a drawback of all approaches as dscussed n the prevous secton: Smply lookng at how a change n A affects performance does not measure the effect of captal constrants on performance. Ths would only be true for the subset of entrepreneurs wth nsuffcent opportunty to obtan captal. Fgure 1 shows the complex theoretcal nterrelatonshps between entrepreneural performance, human captal, assets, captal constrants, and nvestment. Fgure 1 Interrelatonshps between performance, human captal, assets, nvestment and captal constrants + P + -? β A θ k * + In the followng we shall temporarly assume that the postve effects of q on A and k* just cancel out: Captal need (k * - A ) s ndependent of q and does not affect β or P Measurement ssues The centerpece of our analyss s β. Our emprcal equvalent s a dummy varable ndcatng whether an entrepreneur has experenced captal constrants subsequent to the start of her venture. It s formed by the answer to the followng queston: Dd you experence problems n obtanng suffcent (external) captal at the start of your venture? 11

13 Yes, and I ddn t solve the problem 7% Yes, but I solved the problem 17% No 76% We consder the 7% of entrepreneurs who experenced these problems but dd not solve them as beng captal constraned ( β =1). 8 The other 93% s characterzed by * β =0: they are n a poston to operate ther busness at the optmal level,. However, to fnd an as unbased as possble estmate of the condtonal effect of β on k performance,.e. P β we should stll solve a couple of measurement ssues: A Pc β mght seem too severe,.e. be based upwards, due to screenng or redlnng by external captal supplers based on ~ θ. Ths ~ θ has also drect (postve) mpact on performance thereby generatng ths bas. We solve the upward bas resultng from ssue A by means of three measures: HC We nclude a vector of human captal varables, ~ θ known to affect entrepreneurshp performance 9. SC We nclude a vector of socal captal varables, ~ θ known to affect entrepreneurshp performance. 10., nto the equaton that are, nto the equaton that are We nclude varables that we use as addtonal sgnals for entrepreneural ablty, θ, based on the known result of credt scorng by external captal supplers: we know whether banks, famly/frends, and busness partners have contrbuted to. We consder the assgnment of a loan by famly/frends, and n partcular by busness partners as nformatve about unobserved heterogenety. k 8 We consdered the 7%+17% of the sample who answered yes as an alternatve ndcator of captal constrants. Ths weakened the result consderably. The same holds for the alternatve specfcaton where the frst answer s translated nto β =1, the second nto β =0.5 and the thrd s equvalent to β =0. Ths rendered much weaker results too. 9 Emprcal support can be found n for nstance Bates, 1990; Bosma et al. 2002; Cooper et al., 1994; Cressy, 1996; De Wt and Van Wnden, 1993; Le, 1999; Lndh and Ohlsson, 1996; Taylor, 1999; Van Praag and Cramer 2001; Van Praag, 2002; Pennngs et al Emprcal evdence on whch the choce of θ ~ SC and Presendorfer, 1998 and Pennngs et al., s based can be found n Bosma et al., 2002; Brüderl 12

14 B Pc β mght seem too weak,.e. be based downwards, due to Tme hypothess People who spend a consderable proporton of ther tme on other pad actvtes wll probably show weaker performance and smultaneously face lower captal constrants. Wthout any addtonal correctve measures, ths spurous effect would be ncluded n an estmate of the coeffcent for β leadng to a downward bas. Motvaton hypothess Fnancal ndependence from the venture mght be a cause for lower captal constrants and mght smultaneously result n a weaker motvaton. Wthout correcton, ths spurous effect would agan be mstakenly ncluded n an estmate of the coeffcent for β and lead to a downward bas. A thrd hypothess that would cause a downward bas of the estmated effect of s the over-nvestment /overconfdence hypothess. Overconfdent entrepreneurs mght am at larger than effcent amounts of startup captal. When they cannot get access to the large amount they desre, they feel constraned and report so. Unfortunately, we are unable to test ths hypothess that would agan lead to an underestmate of the effect of the captal constrant on performance: the overconfdent entrepreneur wll perform better gven a lower and thereby more optmal amount of captal. We try to correct the potental downward bas resultng from the frst and second ssue headed by B by means of the ncluson of addtonal varables: Tme hypothess: a dummy varable ndcatng whether the entrepreneur spends more than twenty hours per week on other pad actvtes. Motvaton hypothess: (1) A categorzed varable amount of other ncome avalable, and (2) A dummy varable ndcatng whether the entrepreneur s fnancally dependent on the stream of ncome generated by her venture. We conclude ths subsecton by a comparson of the dstnctve (potental) (ds)advantages of ths approach to the problems and favorable features attached to the emprcal approaches as descrbed n the prevous secton. Frst and foremost, our estmate of β s coeffcent show the effect on performance of beng captal constraned for the group of entrepreneurs who are captal constraned. Other approaches generate an estmate of the effect of an ncrease n assets on performance for all entrepreneurs at the same tme, whether they face captal constrants or not. β 13

15 Secondly, our estmate of β s coeffcent embodes the effect of captal constrants that reman after the possblty of obtanng external fnance has been explored. The other approaches assume that the external route to obtan fnance s totally naccessble. A thrd, though rather lmted, relatve advantage of the current approach s that we try to cope wth the causalty ssue n a more elaborate way. We embody many controls, also for access to captal from lenders who presumably have more nformaton about the type and ntentons of the entrepreneur than we as researchers do. In ths manner, we try to dsentangle the real effect of nsuffcent captal from the spurous effect. We cannot conceve of a better way of dong ths, snce nstrumental varable methods and other methods that cope n a more fashonable way wth possble endogenety of access to captal are all napproprate n ths case. Identfyng varables or nstruments are lackng by defnton snce access to captal s a functon of ownershp of captal and perceved busness acumen. A potental drawback of our approach fnally s that we rely on the self-reported subjectve answers of ndvdual entrepreneurs as to whether they started ther venture wth or wthout sgnfcant captal constrants. Over or underreportng of ths varable would lead to based results. Estmaton models Let Π be the proft (P 1 ) for respondent n 1997, and x j respondent s value of determnant j n We specfy the logarthm of proft as the dependent varable rather than proft tself, so that changes n the determnants nfluence relatve proft rather than absolute proft (n e.g. euros). The estmated model s the followng: J Π Π Π Π 2 ln Π = α + β j xj + ε, where ε ~ N(0, σ Π ). j= 1 The model for employment s analogous to the model for proft. Let L be the cumulated employment (n fte) generated by respondent between 1994 and 1997, and x j respondent s value of determnant j n The regresson equaton then reads: J L L α + β j xj + j=1 L L 2 ln L = ε, where ε ~ N(0, σ L ). 14

16 Both the proft and the employment measures have zero as the lower bound. Negatve profts are not observed, whle negatve employment s non-nterpretable. Therefore, both equatons are estmated usng tobt regressons. For duraton, we apply a log-logstc survval model. (See Lancaster, 1992, p. 44). 4. DATA Sample The panel results from annual questonnares conducted on a sample taken from all newly regstered frms n the frst quarter of 1994 as reported n the database of the Dutch Chamber of Commerce. Frms were ncluded n the sample upon meetng several condtons. They had to be founded n the frst quarter of Frms reregsterng due to a change n Chamber of Commerce dstrct or some other change n locaton, actvtes or legal status were excluded. Frms that used to be part of a prevously exstng frm were also excluded. The agrcultural and mnng sectors reman unconsdered as well. The ntal 10,627 frms were contacted by telephone. A total of 3,000 frm founders agreed to partcpate n the survey. 1,939 frm founders fnally completed the 1994 questonnare. Our base sample however s somewhat smaller because we dscarded entrepreneurs from ths database for several reasons. 250 frm founders appeared to be hardly more than hobbysts : they had an addtonal smultaneous employment contract of more than forty hours per week. We furthermore dscarded 53 observatons whose busnesses appeared to have exsted for less than 2 months n total. Twenty-eght observatons were deleted because they ddn t complete the vtal queston concernng captal constrants. Of the remanng 1,608 frm founders, 1,323 answered all subsequent annual questonnares of Ths mples an attrton rate of 18% (285 observatons). The frm sze and ndustry dstrbutons of the 1994 and 1997 respondents were comparable to those of the ntal sample. The frst questonnare conssted of 90 questons dvded n the categores general, frm, work experence, motves, foundng stuaton, captal and nvestments, problems encountered, control and subcontractng, envronment and market, sales and vulnerablty, targets and strategy, performance and expectatons as well as a rch set of background varables. The questonnare n 1997 contaned a total of 44 questons, n approxmately the same categores. 15

17 The nformaton from the frst questonnare s used for the constructon of potental determnants of performance, the ndependent varables n the analyss. Entrepreneural performance tself s exclusvely measured by means of varables constructed from the subsequent questonnares. In ths manner, we avod problems of serally reversed causalty. Measures of entrepreneural performance We employ three performance measures: P 1, P 2 and P 3. The frst consders proft gven survval and s equated to the proft level of The entrepreneur has then been actve for three years. In partcular, proft levels of the frst two years mght be somewhat msleadng due to ntal (sunk) nvestments that are wrtten off at the expense of proft levels. For entrepreneurs that are known to have ended ther busnesses, the proft varable s equated to zero. The second measure used s the cumulatve employment created n the perod We consder the employment created (n fulltme equvalents) by an entrepreneur as a measure of socal performance n contrast to proft that can be seen as a measure of ndvdual performance. The thrd performance measure s survval duraton. Is the frm stll n busness n 1997? And f not, how many months has the entrepreneur survved? Table 2 shows descrptves of the performance measures and ther ntercorrelatons. The table dstngushes entrepreneurs wth and wthout captal constrant. The total sample sze of 1,323 refers to the number of entrepreneurs for whom at least one of the dependent varables s avalable. The number of vald observatons for analyses on P 1, P 2 and P 3 are 1,168, 989, and 1,073 respectvely. These samples nclude entrepreneurs who haven t survved untl 1997: ther proft level s equated to zero, ther cumulatve employment has been cumulated up untl ther ext. The average entrepreneur earned an annual proft level of 20,200. Exclusvely consderng the group of entrepreneurs that has survved the frst 42 months, the maxmum possble wthn the panel, ths number ncreases to 28,000. To relate ths to for nstance the ncome of a Dutch wage earner, we menton that the (gross) 11 Other employment measures that have been nvestgated are employment growth and the 1997 employment level. Both alternatves showed results that dd not dffer sgnfcantly from cumulated employment. 16

18 average ncome n the same year amounted to 22, There s a huge varance n ths ncome, as s well known for entrepreneural postons. Table 2 Descrptve statstcs and correlatons of performance measures Performance measures, P j Total sample (N=1323) Wth captal constrant: β =1 (N c =93) Wthout captal constrant: β =0 (N n =1230) Correlatons Mean Std Mean Std Dev Mean P Std Dev 1 P 2 P 3 Dev P 1 : Proft ( Dfl) P 2 : Cumulated ** 1 employment (fte) P 3 : Survval (months) ** 0.11** 1 ** Sgnfcant at 5 percent level. The average cumulated employment over the past three years s more than 3.5 fulltme equvalents, wth a large varance and a very skewed dstrbuton. Consderng the group of actve entrepreneurs n 1997, the average cumulated employment amounts to even 4.8 fte. The medan actve entrepreneur has no employees (66% actually has no employees), whereas 72% of the sample has generated cumulatve employment levels of less than 1 fulltme equvalent. Ten percent has more than 10 fte employees, fve percent more than 20 fte. Consderng the dstrbutons and averages of annual employment levels over the years , we see the average ncreasng from 0.41 n 1994, to 0.57 n 1995, 0.74 n 1996 to 0.99 n At the same tme, the percentage of entrepreneurs wthout any personnel decreases from 86% n 1994 to 38% n Ths growth s dfferent for captal constraned entrepreneurs: ther average frm sze ncreases from 0.22 n 1994 to 1.27 n 1997, whereas 25% of ths group of entrepreneurs has no personnel n The average (truncated) survval duraton s slghtly more than 3 years: most entrepreneurs (65%) have survved 42 months, the entre perod from the start of the panel tll the last ntervew n Sx percent has not survved ther frst year, another 6% ded wthn ther second year, whereas 4% exted wthn ther thrd year. The frst year hazard rate out of entrepreneurshp among captal constraned entrepreneurs s almost twce as hgh: 12% of these entrepreneurs do not survve ther frst year. 12 Source: Central Bureau of Statstcs (CBS) Netherlands 17

19 The average scores on the three performance measures are all lower for the group of captal constraned entrepreneurs than for ther unconstraned counterparts: the dfferences however are all statstcally nsgnfcant. Table 2 fnally shows that the three measures of performance used are (unsurprsngly) postvely correlated wth each other. Determnants of entrepreneural performance Table 3 Descrptve statstcs of potental determnants of small busness performance ALL CAPITAL ENTREPRENEURS: CONSTRAINED N=1382 ENTREPRENEURS: β =1 and N C =93: Descrptve Statstcs Mean Std. Devaton Mean Std. Devaton CAPITAL CONSTRAINT HUMAN CAPITAL Experence n busness ownershp Experence n actvtes relevant to busness ownershp Experence n ndustry Age dvded by Age dvded by 10, then squared Hgh educaton Experence as an employee SOCIAL CAPITAL Contact wth entrepreneurs n networks Way of nformaton gatherng: - General channels Drect busness relatons Commercal relatons Fellow entrepreneurs Emotonal support from spouse Presence of spouse FINANCIAL SCREENING Share own captal n start captal Fn. also by bank Fn. also by loan from famly Fn. also by busness partner(s) TIME CONSTRAINT Spent 20+ hours on other pad actvtes MOTIVATION Other ncome avalable (categores) Dependent on profts from busness CONTROL VARIABLES Gender No afflatons wth other busnesses Goal: employment growth Motve: hgher ncome Hours worked at the start (categores)

20 Table 3 shows descrptve statstcs of the potental (and hypotheszed) determnants of entrepreneurshp performance. In order to obtan an unbased estmate of the effect of captal constrants on performance, we dstngush the followng categores of varables: human captal, socal captal, fnancal screenng, tme constrant, and motvaton varables. Descrptves of control varables have been ncluded too. These categores are dscussed presently. Human captal The vector of human captal varables that s ncluded n the model has the followng elements. Professonal experence of the busness founder s measured wth respect to several dmensons: experence n busness ownershp tself, experences assocated wth busness ownershp (e.g. experence n leadershp) and experence n the sector n whch the founded busness s actve. Only seven percent of the entrepreneurs have prevous experence n entrepreneurshp; more than seventy percent clams to have experence n leadershp assocated actvtes. Two thrd of the entrepreneurs have gathered experence n the ndustry of ther busness choce before startng up ther busnesses. More than 90% of the entrepreneurs has experence n wage employment. These fgures are no dfferent for the group of captal-constraned entrepreneurs exclusvely. The average startng age s 42. The effect of age on performance wll be analyzed by the ncluson of age and age squared nto the regresson equatons. Educaton enters the analyses as a dummy varable, dfferentatng the hgh-educated busness founders (academc/hgher vocatonal formal educaton) from the less educated ones. There are obvously fewer hgher educated entrepreneurs wthn the group of captal constraned entrepreneurs (19% versus 29%) than average. SC Socal captal As was mentoned, a vector of socal captal varables, ~ θ n the model. The vector conssts of the followng varables. A dummy varable s ncluded measures whether the busness owner had (planned) contacts wth other entrepreneurs through an entrepreneurs network n the frst year of operaton. 28% of the entrepreneurs has such network contacts. Ths percentage s no dfferent for captal constraned entrepreneurs. We also derved nformaton on ntal(ly planned) strateges used by busness owners to keep up wth (envronmental) developments relevant for ther busnesses. Respondents rated the actvty on ten possble actons. They ndcated whether they 19

21 frequently, sometmes or never used certan nformaton gatherng channels, of whch some are closely related. Factor analyss revealed four major strateges of channel usage: Focus on the branch (man ndcators: keep up wth lterature; attendng congresses, courses and branch exchanges) Focus on drect busness relatons (man ndcators: nformaton from customers and nformaton from supplers) Focus on commercal relatons (man ndcators: nformaton from banks; commercal cooperaton; advse from experts) Focus on fellow entrepreneurs. Usng nformaton channels s closely related to socal captal, though t s usually not consdered as such. It reflects the strategy used to retreve relevant nformaton from relatonshps. Snce the relatonshps themselves do not occur naturally and snce the nformaton retreval wthn each relatonshp somehow ndcates the ntensty of the relatonshp, we label the resultng factors as elements of socal captal. The factors resultng from factor analyss are standard normally dstrbuted. Fnally, a partner and especally an emotonally supportve partner are consdered potentally valuable socal captal. 84% of the entrepreneurs have spouses of whom 73% s consdered emotonally supportve. Descrptves for Fnancal screenng varables, used as addtonal sgnals for entrepreneural ablty, θ, are shown n Table 3. We consder whether banks, famly and frends, and busness partners have contrbuted to k. The assgnment of a loan by famly members and frends, and n partcular by busness partners s consdered as nformatve about unobserved heterogenety. The average percentage of own captal n the actual total amount of start captal s 66%, and (remarkably) slghtly lower for captal constraned entrepreneurs (56%). However, snce the dstrbuton s qute skewed, Table 4 s nformatve: t shows that 47% of the total number of entrepreneurs starts whle exclusvely relyng (wllngly or not) on ther own captal. Ths percentage s somewhat lower, 42%, for captal constraned entrepreneurs. Furthermore, one thrd of all captal constraned entrepreneurs gets loans from banks, thereby not dvergng from the average. Captal constraned entrepreneurs 20

22 however get fnancal means from frends and famly almost twce as frequently. Trust (and captal) by busness partners s obtaned by 10% of all entrepreneurs, whereas captal constraned entrepreneurs obtan ths knd of captal n 6% of the cases. Table 4 Share of own captal n total amount of start captal Share All observatons aptal constraned entrepreneurs: β = Tme constrant Entrepreneurs who spend more than twenty hours per week on other pad actvtes are consdered as tme constraned: they are hypotheszed to have lower entrepreneural performance. One ffth of the sample has tme constrants. Ths share s not dfferent among the captal constraned entrepreneurs. Motvaton The extent to whch the entrepreneur s motvated to perform well mght be negatvely affected by a lack of fnancal dependence on the recepts of the busness: we therefore measure whether the entrepreneur s dependent on the profts from the busness and whether other ncome s avalable. 28% of all entrepreneurs s totally dependent on the recepts from the busness, whereas 37% of the captal constraned entrepreneurs has the same dependent poston. Control varables The commonly used set of control varables, ncludng ndustres, gender, and startup motvaton, s fnally added to the regressons 21

23 5. ESTIMATION RESULTS Profts The frst column of Table 5 shows the result from the Tobt estmaton wth (log) proft as the dependent varable and only the captal constrant and some control varables as the ndependent varables. The estmaton result s consstent wth bndng captal constrants: entrepreneurs who suffer from a lack of captal for ther ntal busness nvestments have 63% lower profts. However, as was expected, column II n Table 5 shows that the effect of captal constrants on proft dmnshes to 59% when controllng for human captal effects, the captal constrant stll beng sgnfcant. Human captal, as was assumed, appears to smultaneously affect performance postvely and the captal constrant tself negatvely (makng ts effect less severe). The man determnants of performance wthn the category of human captal factors are varous sorts of experence and educaton. The most valuable type of experence s wthn-ndustry experence: havng worked (as an employee) n the ndustry to whch the busness belongs, ncreases proft, ceters parbus by 70%. Experence n busness ownershp ncreases profts by 50%, whereas general work experence as an employee ncreases proft by 40%. 13 Hgher educated entrepreneurs earn a 20% return to ther educaton. 14 Controllng for socal captal factors (column III) has the same expected dmnshng effect on the captal constrant as was the case for human captal: the coeffcent further decreases from 59 to 52% and remans sgnfcant. The most mportant socal captal factor for expected profts s a spouse s emotonal support. Other socal captal factors of nfluence are the usage of certan nformaton gatherng channels. Havng and explotng commercal contacts and contacts wth fellow entrepreneurs seem to pay off. Our thrd hypothess, that the captal constrant dmnshes when correctng for fnancal screenng factors, s not valdated n ths exercse (column IV). The captal constrant decreases from 52 to 51% only, and remans sgnfcant. Moreover, fnancal screenng factors have no addtonal sgnfcant effect on profts, suggestng 13 The latter effect of general work experence on proft does not confrm expectatons based on prevous emprcal research (cf. Van Praag 2002) 14 Ths s of course an overestmate of the unbased effect of educaton on performance: a probably consderable selecton bas has not been corrected for. 22

24 that these factors do not reveal any unobserved heterogenety n addton to human and socal captal factors that are nfluental for proft potental. Table 5 Estmaton results: Captal Constrants and Profts (P 1 ) PROFIT I II III IV V VI CAPITAL CONSTRAINT ** ** ** ** ** ** Human captal Experence n busness ownershp 0.50 ** 0.50 ** 0.49 ** 0.54 ** 0.54 ** Experence relevant to busness ownershp Experence n ndustry 0.71 ** 0.67 ** 0.67 ** 0.66 ** 0.65 ** Age dvded by Age dvded by 10, then squared Hgh educaton 0.20 * 0.19 * * 0.22 ** Experence as an employee 0.39 * 0.36 * 0.35 * 0.41 ** 0.40 * Socal captal Contact wth entrepreneurs n networks Way of nformaton gatherng: - General channels Drect busness relatons Commercal relatons 0.10 ** 0.10 ** 0.10 ** 0.09 * - Fellow entrepreneurs 0.11 ** 0.11 ** 0.11 ** 0.10 ** Emotonal support from spouse 0.51 ** 0.52 ** 0.49 ** 0.49 ** Presence of spouse Fnancal screenng Share own captal n start captal Fn. also by loan from famly Fn. also by bank Fn. also by busness partner(s) Tme constrant Spent 20+ hours on other pad actvtes ** ** Motvaton Other ncome avalable Dependent on profts from busness 0.19 Control varables Gender 0.49 ** 0.38 ** 0.39 ** 0.39 ** 0.40 ** 0.39 ** No afflatons wth other busnesses 0.58 ** 0.49 ** 0.58 ** 0.61 ** 0.62 ** 0.61 ** Goal: employment growth 0.37 ** 0.34 ** 0.29 * 0.28 * Motve: hgher ncome 0.40 ** 0.35 ** 0.33 ** 0.33 ** 0.35 ** 0.34 ** Hours worked at the start 0.45 ** 0.37 ** 0.35 ** 0.34 ** 0.30 ** 0.28 ** Constant ** ** ** ** ** ** # obs Log Lkelhood * sgn. at 10% level ; ** sgn. at 5% level The addton of the next two blocks of varables (columns V and VI n Table 5) serves to correct for the potental downward bas n the estmate for the captal constrant due to tme and motvatonal constrants (see secton 2). It appears that the ncluson of ndcators for tme and motvatonal constrants nto the regresson equaton does not, contrary to expectatons, ncrease the absolute value of the coeffcent pertanng to 23

25 the captal constrant, although the tme constrant has the expected negatve effect on proft. The remanng as unbased as possble effect of the captal constrant on proft s a dsadvantageous 51%. Duraton Table 6 Estmaton results: Captal Constrants and Duraton (P 2 ) Duraton I II III IV V VI CAPITAL CONSTRAINT ** * * * * * Human captal Experence n busness ownershp Experence relevant to busness ownershp 0.38 ** Experence n ndustry 0.58 ** 0.53 ** 0.54 ** 0.53 ** 0.52 ** Age dvded by Age dvded by 10, then squared Hgh educaton Experence as an employee 0.51 * Socal captal Contact wth entrepreneurs n networks Way of nformaton gatherng: - General channels 0.29 ** 0.29 ** 0.29 ** 0.29 ** - Drect busness relatons Commercal relatons Fellow entrepreneurs Emotonal support from spouse Presence of spouse Fnancal screenng Share own captal n start captal Fn. also by loan from famly Fn. also by bank Fn. also by busness partner(s) Tme constrant Spent 20+ hours on other pad actvtes Motvaton Other ncome avalable Dependent on profts from busness 0.07 Control varables Gender 0.38 ** ** 0.38 ** 0.38 ** 0.37 ** No afflatons wth other busnesses 0.77 ** 0.77 ** 0.92 ** 0.91 ** 0.91 ** 0.91 ** Goal: employment growth Motve: hgher ncome Hours worked at the start 0.35 ** 0.27 ** 0.26 ** 0.26 ** 0.26 ** 0.25 ** Constant 3.29 ** # obs Log Lkelhood * sgn. at 10% level ** sgn. at 5% level Table 6 shows determnants of duraton n busness (P 2 ). It shows numbers for the captal constrant n the same order of magntude: rangng from 63% wthout 24