Banks' Screening and the Leverage of Newly Founded Firms

76 Pages Posted: 21 Nov 2017 Last revised: 26 Jun 2019

See all articles by Maria Cecilia Bustamante

Maria Cecilia Bustamante

University of Maryland - Department of Finance

Francesco D'Acunto

Boston College

Date Written: June 1, 2019

Abstract

Banks finance newly-founded firms extensively despite severe asymmetric information. Whereas the demand for credit usually follows from entrepreneurs' lack of liquidity, we ask why and how banks supply credit to new firms of unknown value. We propose a model of credit allocation in which, due to banks' screening, new firms with higher future value issue debt below capacity to avoid costly investment delay. Consistent with this prediction, new firms with a lower first leverage ratio (initial leverage) perform better ex post in a unique US representative sample. In the model and in the data, this negative association is more pronounced in lending markets in which banks have greater market power, and also stronger incentives to screen. Our results are robust to controlling for characteristics such as entrepreneurs' net worth, skin in the game, and education levels. We conclude that banks ensure that profitable new ventures develop.

Keywords: Entrepreneurial Finance, Screening, Lending, Kauffman Firm Survey, Capital Structure

JEL Classification: D82, G21, G32, G34, L26

Suggested Citation

Bustamante, Maria Cecilia and D'Acunto, Francesco, Banks' Screening and the Leverage of Newly Founded Firms (June 1, 2019). Available at SSRN: https://ssrn.com/abstract=3073044 or http://dx.doi.org/10.2139/ssrn.3073044

Maria Cecilia Bustamante (Contact Author)

University of Maryland - Department of Finance ( email )

Robert H. Smith School of Business
Van Munching Hall
College Park, MD 20742
United States

HOME PAGE: http://https://sites.google.com/a/rhsmith.umd.edu/mcbustam/?pli=1

Francesco D'Acunto

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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