Cost of External Finance and Selection into Entrepreneurship

34 Pages Posted: 21 Mar 2008 Last revised: 25 Apr 2011

See all articles by Ramana Nanda

Ramana Nanda

Harvard University - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER)

Date Written: January 15, 2008

Abstract

This paper examines the extent to which the positive relationship between personal wealth and entry into entrepreneurship is due to financing constraints. I exploit a tax reform and use unique micro-data from Denmark to study how exogenous changes in the cost of external finance shape both the probability of entering entrepreneurship and the characteristics of those who become entrepreneurs. As expected, differences-in-differences estimates show that the entry rates for individuals who faced an increase in the cost of finance fell by 40% relative to those whose cost of external finance was unchanged. However, while some of the fall in entry was due to less wealthy individuals with high human capital (confirming the presence of financing constraints), the greatest relative decline in entry came from individuals with lower human capital, many of whom were above median wealth. This finding suggests that an important part of the positive relationship between personal wealth and entrepreneurship may be driven by the fact that wealthy individuals with lower ability can start new businesses because they are less likely to face the disciplining effect of external finance.

Keywords: Financing Constraints, Entrepreneurship, Entry

JEL Classification: D31, H24, J24, M13

Suggested Citation

Nanda, Ramana, Cost of External Finance and Selection into Entrepreneurship (January 15, 2008). Harvard Business School Entrepreneurial Management Working Paper No. 08-047, Available at SSRN: https://ssrn.com/abstract=1084115 or http://dx.doi.org/10.2139/ssrn.1084115

Ramana Nanda (Contact Author)

Harvard University - Entrepreneurial Management Unit ( email )

Boston, MA 02163
United States

HOME PAGE: http://www.people.hbs.edu/rnanda

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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