Home Equity Finance and Entrepreneurial Performance - Evidence from a Mortgage Reform
43 Pages Posted: 7 Oct 2014 Last revised: 26 Sep 2015
Date Written: September 25, 2015
We study how a mortgage reform that enabled home equity-based borrowing had an impact on entrepreneurship, using individual- and firm-level micro data from Denmark. The reform allowed entrepreneurs to bypass the project screening function of banks, by instead relying on the value of housing collateral to access credit. This enables us to study the efficacy of banks' screening technologies by examining the quality of the marginal entrants who benefited from reform. As expected, the reform relaxed constraints and led to an increase in entrepreneurship through the collateral channel. However, on average, new entrants were more likely to start businesses in sectors where they had no prior experience, were more likely to fail and had lower performance than those who did not benefit from the reform. Our results provide evidence that despite asymmetric information and opacity in startup lending, banks' screening can play an important role in credit allocation to more promising entrepreneurs. In such instances, the marginal individuals selecting into entrepreneurship when they can bypass bank screening will tend to start businesses that are of lower quality than the average existing businesses, leading to an increase in churning entry that may not translate into an equivalent increase in the overall level of entrepreneurship.
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