Who Needs Credit and Who Gets Credit? Rebel A. Cole DePaul University and Krähenbühl Global Consulting For presentation at a Symposium on Small Business

Who Needs CreditWho Needs Creditandand

Who Gets Credit?Who Gets Credit?

Rebel A. ColeRebel A. Cole

DePaul University and Krähenbühl Global ConsultingDePaul University and Krähenbühl Global Consulting

For presentation at aFor presentation at a

Symposium on Small Business FinancingSymposium on Small Business FinancingSponsored bySponsored by

SBA Office of AdvocacySBA Office of AdvocacyJuly 9, 2009July 9, 2009

Rebel A. Cole: Rebel A. Cole: Who Needs Credit and Who Gets Credit? Who Needs Credit and Who Gets Credit?

Summary:Summary:Who Needs Credit and Who Gets Credit?Who Needs Credit and Who Gets Credit?

This study uses data from the 1993, 2998 This study uses data from the 1993, 2998 and 2003 Surveys of Small Business and 2003 Surveys of Small Business Finance to explore, among privately held Finance to explore, among privately held small firms, who needs credit and who small firms, who needs credit and who gets credit.gets credit.

We break the credit allocation process We break the credit allocation process down to three steps:down to three steps:• Who needs credit?Who needs credit?• Who applies for credit?Who applies for credit?• Who gets credit?Who gets credit?


Summary:Summary:Who needs credit?Who needs credit?

There are three groups of firms that need There are three groups of firms that need credit:credit:• Firms that apply for credit.Firms that apply for credit.

Firms that apply for and are granted credit.Firms that apply for and are granted credit. Firms that apply for and are denied credit.Firms that apply for and are denied credit.

• Firms that need credit but do not apply.Firms that need credit but do not apply. Who doesn’t need credit?Who doesn’t need credit?

• All other firms.All other firms.


Summary:Summary:Why is this study important?Why is this study important?

No study of which we are aware analyzes the No study of which we are aware analyzes the “No-Need” firms.“No-Need” firms.

Almost half of all small firms.Almost half of all small firms. Many existing studies ignore “discouraged” firms Many existing studies ignore “discouraged” firms

that need credit but don’t apply.that need credit but don’t apply. ““Discouraged” firms are more than twice as Discouraged” firms are more than twice as

numerous as “Denied” firms. numerous as “Denied” firms. To improve availability of credit, it is critically To improve availability of credit, it is critically

important to better understand these firms.important to better understand these firms. Many studies pool “discouraged” firms with Many studies pool “discouraged” firms with

“denied” firms to analyze credit allocation.“denied” firms to analyze credit allocation. This can lead to faulty inferences if the two groups This can lead to faulty inferences if the two groups

differ systematically.differ systematically.


Summary:Summary:Key FindingsKey Findings

““No Need” firms look a lot like “Approved” No Need” firms look a lot like “Approved” firms and appear to follow the Pecking-firms and appear to follow the Pecking-Order theory of capital structure.Order theory of capital structure.• Firms use internal rather than external Firms use internal rather than external

finance if they are finance if they are LargerLarger More ProfitableMore Profitable More LiquidMore Liquid Less highly leveredLess highly levered Higher credit quality at both firm and owner Higher credit quality at both firm and owner

level.level.



““Discouraged” firms look a lot like Discouraged” firms look a lot like “Denied” firms but show significant “Denied” firms but show significant differences:differences:• SmallerSmaller• More liquidMore liquid• YoungerYounger• Have controlling owners who:Have controlling owners who:

are female, are female, Are BlackAre Black Have less personal wealthHave less personal wealth



Results for “Denied” firms vs. “Approved” Results for “Denied” firms vs. “Approved” firms are consistent with existing firms are consistent with existing literature, esp. studies using the 1993 literature, esp. studies using the 1993 SSBF. Denied firms are more likely to be:SSBF. Denied firms are more likely to be:• SmallerSmaller• More highly leveredMore highly levered• Worse firm and owner credit qualityWorse firm and owner credit quality• Less personal wealthLess personal wealth• Black-ownedBlack-owned


Methodology:Methodology:Classification of FirmsClassification of Firms

First, we classify firms into one of four First, we classify firms into one of four categories of “borrower” types based upon categories of “borrower” types based upon their responses to three questions about their responses to three questions about their “most recent loan requests” during their “most recent loan requests” during the previous three years:the previous three years:• Did they apply?Did they apply?• Were they approved or rejected?Were they approved or rejected?• Did they need credit but not apply Did they need credit but not apply

because they feared rejection?because they feared rejection?


Methodology:Methodology:Three-Step Selection ProcessThree-Step Selection Process

(1)Need

Credit?

(2)Apply for Credit?

(3)Get

Credit?

No

Yes

Yes

Yes

No

No

Non-Borrower

Discouraged Borrower

Unsuccessful Borrower

Successful Borrower


Methodology:Methodology:Univariate and Multivariate TestUnivariate and Multivariate Test

Once we have classified each firm, we Once we have classified each firm, we calculate univariate statistics for each calculate univariate statistics for each group and test for significant differences in group and test for significant differences in means across groups.means across groups.

We then run a sequence of three logistic We then run a sequence of three logistic regression models to explain each step of regression models to explain each step of the credit approval process: the credit approval process: • 1. Need credit? (Yes or No?)1. Need credit? (Yes or No?)• 2. Apply for credit? (Yes or No?)2. Apply for credit? (Yes or No?)• 3. Get credit? (Approved or Denied?)3. Get credit? (Approved or Denied?)


Key Results:Key Results:Credit-Market OutcomesCredit-Market Outcomes

1993 1998 2003

NoNeed 51.6% 60.9% 55.9%

Approved 27.1% 17.8% 29.3%

Discouraged 14.8% 15.7% 10.5%

Denied 6.5% 5.6% 4.4%

All 100.0% 100.0% 100.0%


Credit Market Outcomes 1993

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Denied

Discouraged

Approved

NoNeed



0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Denied

Discouraged

Approved

NoNeed



0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Denied

Discouraged

Approved

NoNeed


Key Results:Key Results:Percentage of Loan Applications DeniedPercentage of Loan Applications Denied

Obs. % Obs. % Obs. %

Black 166 48.2% 73 57.1% 43 66.6%

Asian 76 30.2% 47 37.3% 51 11.5%

Hispanic 94 18.4% 71 47.5% 54 16.5%

Female 270 25.0% 164 25.9% 274 14.8%

White Male 1,108 16.8% 521 19.3% 1,076 10.8%

20031993 1998


Explanatory Variables:Explanatory Variables:

To select our explanatory variables, we To select our explanatory variables, we rely upon the existing literature on the rely upon the existing literature on the availability of credit, along with capital availability of credit, along with capital structure theory.structure theory.

We group these variables into three We group these variables into three vectors:vectors:• Firm CharacteristicsFirm Characteristics• Market CharacteristicsMarket Characteristics• Owner CharacteristicsOwner Characteristics


Explanatory Variables:Explanatory Variables:Firm CharacteristicsFirm Characteristics

SizeSize AgeAge Organizational formOrganizational form CreditworthinessCreditworthiness Financial performance and conditionFinancial performance and condition


Explanatory Variables:Explanatory Variables:Market CharacteristicsMarket Characteristics

Banking concentrationBanking concentration Urban/Rural Location of the FirmUrban/Rural Location of the Firm


Explanatory Variables:Explanatory Variables:Owner CharacteristicsOwner Characteristics

AgeAge ExperienceExperience EducationEducation Personal WealthPersonal Wealth Personal CreditworthinessPersonal Creditworthiness Race, Ethnicity and GenderRace, Ethnicity and Gender


Key Results:Key Results:Probability of Loan Approval by Race, Ethnicity and GenderProbability of Loan Approval by Race, Ethnicity and Gender

Controlling for Firm, Market and Owner CharacteristicsControlling for Firm, Market and Owner Characteristics

Marginal Marginal MarginalVariable Effect t-stat Effect t-stat Effect t-stat

Owner Characteristics:

Black Owner -0.096 -2.41 b -0.168 -3.45 a -0.179 -6.50 a

Asian Owner -0.056 -1.19 -0.107 -2.21 b -0.026 -0.83

Hispanic Owner -0.008 -0.19 -0.173 -3.94 a -0.005 -0.14

Female Owner -0.016 -0.76 -0.003 -0.09 0.034 2.13 b

1993 1998 2003


Summary and Conclusions:Summary and Conclusions:

In this study, we examine the availability of credit In this study, we examine the availability of credit to small privately held U.S. firms using data from to small privately held U.S. firms using data from the SSBFs.the SSBFs.

We make at least three important contributions to We make at least three important contributions to the literature.the literature.


Summary and ConclusionsSummary and Conclusions

First, we provide the first rigorous analysis of the First, we provide the first rigorous analysis of the differences in our four types of firms: non-differences in our four types of firms: non-borrowers, discouraged borrowers, denied borrowers, discouraged borrowers, denied borrowers and successful borrowers. borrowers and successful borrowers.

Our findings have important implications for Our findings have important implications for interpreting previous research that has combined interpreting previous research that has combined these groups in ways that our results suggest are these groups in ways that our results suggest are inappropriate, such as pooling discouraged inappropriate, such as pooling discouraged borrowers with denied borrowers in analyzing borrowers with denied borrowers in analyzing availability of credit.availability of credit.



Second, we provide an analysis of credit Second, we provide an analysis of credit availability that properly accounts for the availability that properly accounts for the inherent self-selection mechanisms involved in inherent self-selection mechanisms involved in the credit application process: the credit application process:

• Who needs credit?Who needs credit?• Who applies for credit, Who applies for credit,

conditional upon needing credit? conditional upon needing credit? • Who receives credit, Who receives credit,

conditional upon applying for credit? conditional upon applying for credit?



Third, we provide the first evidence from the Third, we provide the first evidence from the 2003 SSBF on the availability of credit to small 2003 SSBF on the availability of credit to small firms. firms.

This survey includes methodological This survey includes methodological improvements on the previous SSBFs (1987, 1993 improvements on the previous SSBFs (1987, 1993 and 1998) that enable us to better address the and 1998) that enable us to better address the issue of availability of credit to small firms. issue of availability of credit to small firms.

Documents

Who Needs Credit and Who Gets Credit? Rebel A. Cole DePaul University and Krähenbühl Global Consulting For presentation at a Symposium on Small Business