Monitoring Costs, Credit Constraints and Entrepreneurship

27 Pages Posted: 16 Jun 2012

See all articles by Sanjay Banerji

Sanjay Banerji

Durham University - Durham Business School

Rajesh Raj

Centre for Multi-Disciplinary Development Research (CMDR)

Kunal Sen

University of East Anglia

Abstract

The vast majority of firms in developing economies are micro and small enterprises owned by families whose members also provide the labour to the units. Often, they fail to grow in size even with the relaxation of credit constraints. In this paper, we show that frictions in the labour market leading to monitoring costs tend to reduce the growth of the firm via two channels: (1) it forces the entrepreneur to devote more time on monitoring hired labour from outside family which curtails her time on productive activities leading to failures of firm's projects. (2) The need to pay a premium wage over the market rate in order to incentivize workers makes it costlier for the firm to expand in size via hiring outside labour. In this framework, we show that possibility of an inverted U- shaped relationship between the credit supply and the size of the firm, measured by hiring of non family labour, indicating frictions in the labour market may outweigh the effects of the easing of borrowing constraints of the firm. We then use a unique data-set comprising large nationally representative surveys of small and micro-enterprises in Indian manufacturing and find support for the existence of such a non-monotonic relationship attributed to both frictions in the credit and labour markets.

Keywords: household enterprises, credit constraint, monitoring costs, entrepreneurship, India

JEL Classification: D22, G10, O16

Suggested Citation

Banerji, Sanjay and Raj, Rajesh and Sen, Kunal, Monitoring Costs, Credit Constraints and Entrepreneurship. Available at SSRN: https://ssrn.com/abstract=2085181 or http://dx.doi.org/10.2139/ssrn.2085181

Sanjay Banerji (Contact Author)

Durham University - Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom
+44-191-334-6336 (Phone)
+44-191-334-6341 (Fax)

Rajesh Raj

Centre for Multi-Disciplinary Development Research (CMDR) ( email )

Dr. B R Ambedkar Nagar
Lakamanahalli
Dharwad, 580004
India

Kunal Sen

University of East Anglia ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom

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