Credit market competition and the nature of firms

Nicola CetorelliFederal Reserve Bank of New York

The research in this paper was conducted while the author was Special Sworn Status researcher of the U.S. Census Bureau at the NYC Census Research Data Center.  Research results and conclusions expressed are those of the author and do not necessarily reflect the views of the Census Bureau. This paper has been screened to insure that no confidential data are revealed.

What we know

Credit market competition important for firms’ life cycle dynamics

More credit competition leads to more entry, more growth, more small size firms, etc.

More competitive credit environment overall a good thing based on standard metrics

Claim:

Credit conditions at time of founding leave imprinting on firms’ own nature (organizational structure, business plans,

managerial resources, …)

Effect is long-lasting

Impact on firms’ population dynamics is deep

Conjecture

1. Non-competitive credit markets Financial capital hard to obtain Prospective entrepreneurs will select solid mix of

organizational structure, business plans, strategies, resources, …

2. Competitive credit markets Capital cheap and plenty, start up and folding costs lower Same entrepreneurs may select less solid package to start

a business Agents that in tougher environment would not undertake

entrepreneurship, might do so now.

HIV-AIDS infection rates

2008 CDC report on HIV-AIDS infection rates among gay men Marked increase in infection rates among 13-24 age group Negligible and even negative rates for older age groups.

One explanation: “treatment optimism”. The successful introduction in the last decade of anti-retroviral therapies

Diminished fear of infection among younger individuals and increased likelihood of engaging in risky behavior.

Impact on population dynamics : Pre-reform vintage firms may adapt

Pre-reform vintage firms may stay true to nature

Post-reform vintage firms may select into more fragile fundamentals

This study

Use Census confidential data on universe of business establishments, 1975-2005

Use data on state-level deregulation removing interstate barriers to entry from out-of-state banks

Follow business establishments over life time and compared life statistics before and after the reform

Findings

Pre-reform vintage firms have lower odds of mortality in post-reform years

Post-reform vintage firms intrinsically more fragile Despite better access to credit, worse odds of

mortality throughout entire life-cycle

Environmental imprinting and structural inertia Well-developed concepts in organizational studies Core of organizational ecology field (Hannan and

Freeman, 1977, 1984, Carroll, 1984, Hannan, 2005). Evolution more from selection of newly founded firms than

from adaptation of pre-existing ones Structural inertia required to survive Arrow (1974): “…the very pursuit of efficiency in

organizations might lead to rigidity and unresponsiveness to change.”

Jovanovic (2001) has recent evidence on imprinting at founding and inertia

Relation to literature Rajan and Zingales (2001): “Financial revolution” affects the

nature of firms.

Schoar (2008): Managerial style. “Recession CEOs” different over lifetime

Finance and the real economy: (Cetorelli and Gambera (2001), Black and Strahan (2002), Cetorelli (2004), Cetorelli and Strahan (2006), Bertrand, Schoar and Thesmar (2007), Kerr and Nanda (2007, WP)

Firm dynamics (Jovanovic, 1982, Hopenhayn, 1992, Albuquerque and Hopenhayn, 2004, Clementi and Hopenhayn, 2006, … )

Identification

Conjecture is about innate fragility

Natural to focus on life’s chances

Estimation of hazard of mortality functions

Identification

0 1 2 3 4 5 ... Age

Reform

Reform

ReformC

B

A

Compare hazard functions at each survival time (age)

Identification

1

0

( | ( ; ) ( | ( ; )

( | ; )

d d

jisy jisy

jisyjisy

S t X f t XL

S t X

1 2 ( )sy sy jisy jisyX Reform Reform Founding time Controls

Results

Group A

Group B Group C

Additional robustness tests Control for state-specific growth

Control for state and industry specific growth

“Vintage” dummies

Reset of regime switch from t to t + 3 (first few years after reform may actually get worse as banking industry reorganize)

Reset from t to t – 3 (interstate dereg final step of a process started with intrastate dereg)

Alternative stories Can this evidence be explained with standard

theories of credit competition? No.

More competition, more credit. Predict all firms with better survival rates post-reform.

Petersen and Rajan (1995) story: young firms better off under monopoly banking, old firms better off under competitive banking. Predict crossing of hazard functions, and no differentiation by vintage (all young firms worse off after the reform)

Alternative stories

Pre-reform vintage firms adapting to new environment? (Rajan and Zingales, 2001)

Implies pre-reform firms get weaker after the credit reform. There should be no difference with post-reform vintage firms.

Alternative stories Bad banks instead of bad firms? No

More competition, banks lower standards and get less efficient at what they do. Implies no differential impact on firms based on vintage. Contrary to evidence. Banks got more efficient after reform (Stiroh and Strahan, 2002)

More competition, just new banks are worse and link up disproportionately with new firms. Contrary to evidence that banks entering in new markets are actually the more efficient ones (Evanoff and Ors, 2008).

Searching for a new theory

In models of credit competition, population characteristics are part of the primitives.

Evidence here suggests a different approach.

Conclusions Credit market reform has a deep impact on

firms’ life cycle dynamics Life expectancy is significantly altered Irrespective of vintage, odds of mortality are

lower after the reform But impact is heterogeneous within firms’

population. Firms of pre-reform vintages have a clear improvement in life’s chances, both in absolute terms and relative to firms of post-reform vintages

Conclusions No natural life ending point for firms. Reform

may determine a progressive aging of population

May be all for the better: reform allows good firms from pre-reform vintages to thrive in conditions of more capital availability

It allows more Googles to be born (in a broader ocean of “would-be-but-should-not-really-be” entrepreneurs)

Conclusions Broader point: Connection with path

dependence theories and institutional economics.

Problems with standard prescription of adopting institutional environment of developed economies.

Evolutionary approach followed here suggests complex impact of institutional reforms.

Initial conditions matter and development paths may not be replicable.