Oh the Financial Ecosystem for SMEs: On the Role of Age and Size as Sources of Risk in SME Lending
9 Pages Posted: 8 Dec 2015
Date Written: December 8, 2015
This paper quantifies the relative impacts of firm age and firm size on the probability of loan default. It is often believed that small firms are more informationally opaque than larger firms and, therefore, that that firm size is negatively correlated with credit risk. To be sure, the small firm universe is populated by many new firms, firms that face “the liability of newness,” may not be managed by experienced entrepreneurs, lack a track record and face unproven factor and product markets. New firms often fail relatively soon after founding. Conversely, many small firms have good credit records, established relationships with lenders and are well managed by experienced owners. Such firms should be relatively good credit risks, but may still be disadvantaged with respect to access to commercial loans. Yet it is the growth of small firms, growth that requires financing, that disproportionately fuels job creation and prosperity. Therefore, we seek to examine the relative impacts on creditworthiness of firm size and firm age. We argue that the perceived creditworthiness of small firms is driven primarily by age of firm: that, controlling for firm age, creditworthiness does not vary appreciably across firm size. We also argue that in adjudicating loan applications, lenders face inefficiencies associated with small lending balances and that this limits access to credit among all small firms: new and established.
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