1. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 1 Financial Constraints, Entry and Post-Entry Growth

2. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 2 Motivation Firm dynamics is good for productivity growth because: (1) New firms replace inefficient incumbents (2) It promotes efficiency-enhancing investment by incumbents Previous studies emphasize:  Adjustment costs induced by incumbent R&D and advertizing  Administrative costs of creating new firms  Labor market regulations We investigate the role of financial constraints as barriers to entry, selection and post-entry growth

3. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 3 In this paper Effects of financial development on entry by firm size Effects of financial development on post- entry growth We use a harmonized firm-level cross country panel data set covering whole population of firms across 16 countries

4. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 4 Main findings FD has a strong positive impact on entry and post-entry growth of firms Impact is larger for small firms and may become negative for larger firms Robust to controlling for entry costs and labor market regulations Labor market regulations not significantly correlated with post-entry growth

5. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 5 Setup Two goods (partial equilibrium analysis):  A numeraire that serves as a production and entry input  A consumption good, at price p with a demand D(p) Each period t, there is a mass 1 of potential entrepreneurs in the consumption good market. An entrepreneur lives two periods. She is characterized by:  Initial capacity T 1 (potential number of employees at date t)  Long-term capacity T 2 (potential number of employees at date t+1) For simplicity, each employee produce one unit and wages equal zero. There is a large number of investors who can only assess the short- term capacity of potential entrepreneurs

6. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 6 Timing  At time t (short term):  Entrepreneurs decide whether to enter and pay a sunk cost b. They may borrow from investors.  Entrepreneurs that enter produce and sell at equilibrium price p  By investing K units of the numeraire good, entrepreneurs may expand their long-term capacity from T 1 to (1+αK)T 1  At time t+1 (long term):  Entrepreneurs produce and sell at equilibrium price p  Entrepreneurs repay their debt

7. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 7 Solving the model without capacity expansion Initial capacity threshold: ex post enforcement requires: L 1 Thus, initial capacity may not be lower than: T* 0 = b / μp  The initial capacity threshold is decreasing in μp. Long term capacity threshold: Profits must be higher than sunk entry costs: T = pT 0 + δpT 1 > b  T 1 > T* 1 = b / δp - T 0 / δ  The long-term capacity threshold is decreasing with p. Price equilibrium: D(p) = S(µp, p) D’(p) is decreasing in p and S(µp, p) is increasing in µp and p.

8. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 8 Impact of financial development Increase the ability to borrow (proportional to μp)  Lowers the initial capacity threshold T* 0 Lowers the equilibrium price p:  Increases the long-term capacity threshold T* 1 Impact on entry and post-entry growth:  Increases entry by small firms (firms just below the previous short term capacity threshold T* 0 )  Decreases entry by large firms (firms just above the previous long-term capacity threshold T* 1 )  Increases post-entry growth because: reduces size at entry & increases growth potentials

9. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 9 Figure 2: Impact on entry of an increase of financial development from µ 0 to µ 1

10. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 10 Solving the model with capacity expansion Higher financial development raises post-entry growth as it increases investment in capacity expansion while again lowering the short-term capacity threshold

11. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 11 Tested predictions Impact of financial development: 1. Increase entry by small firms 2. Decrease entry by large firms 3. Increase post-entry growth Even if we control by the size at entry Partial equilibrium analysis (ignoring economy wide effects through wage and exit options)

12. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 12 DATA (1) Coverage : 16 countries (US, Western and Eastern Europe, Latin America) and 30 sectors, during 1990’s. “Entry” = entry in the database Reflects real entry of all (1+) firms Excludes one-year firms Entry rates are calculated by size categories: s1: 1-19; s2: 20-49; s3: 50-99; s4: 100-499; s5: 500+ “Post-entry growth”= employment growth of surviving firms Calculated as employment 6 years after entry among surviving firms compared with employment at entry

13. 13 DATA (2) Indicators on financial development (outcome):  Private credit / GDP  Stock market capitalization / GDP  Synthetic index: FD = (credit + stock) / GDP We also consider regulatory variables: Bank:  Government ownership  Entry requirements  Regulation of activity  Barriers to foreign entry (Barth Caprio Levine 2003, Micco, Panizza, Yañez 2004, Gwartney, Lawson 2004) Market:  Investor protection  Public or Private registry (Doing Business 2006, Djankov McLiesh Shleifer 2006)

14. 14 Methodology Difference in difference approach (Rajan Zingales 1998):  We test whether financial development has a differential impact in sectors depending on external finance It allows including a variety of fixed effects (by country and sector) Other policy variables as controls:  Employment protection legislation (Frazer Institute) Interacted with the intensity of jobflows in US (source: Bartelsman et al. database)  Entry cost (Frazer Institute) Interacted with the turnover rates in US or with the growth potential of the sector (source: STAN, OECD)

15. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 15 Estimated equations Entry (by country c, industry i, year t and size s): Post-entry growth (by country c and industry i):

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21. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 21 Robustness checks Sensibility to the set of countries and sectors Controls for convergence effects (industry share) Interaction with potential growth (industry growth in US) instead of dependence in external finance Controls for incumbent size growth Post-entry growth at different durations Total employment growth of the cohort

22. P.Aghion, T.Fally, S.Scarpetta Conference on Access to Finance, Wordlbank, March 15-16, 2007 22 EU countries versus US Lower competition and higher regulations in EU versus US banking Stock market capitalisation over GDP: 0.64 for EU15 versus 1.17 for US in 2003 Venture capital: 0.5% of GDP in US versus less than 0.15% for Germany, France, Spain, Italy.