Entrepreneurial Borrowing: Do Entrepreneurs Seek and Receive Enough Credit?

Abstract

This work reviews the literature on entrepreneurial borrowing. The dynamic concept of the “entrepreneurial credit journey†is developed to frame the discussion of supply and demand side issues affecting entrepreneurial borrowing. The entrepreneurial credit journey follows the entrepreneur from the development of credit needs, through application and lending decisions and, beyond, to the consequences of these earlier decisions for firm performance. The literature has traditionally focussed on the lending decision stage, including: problems of credit rationing which may arise due to asymmetric information; and lending technologies to reduce information issues. However, on the demand side, discouraged borrowers, who decide not to apply for fear of rejection, have received increasing attention. There is also greater attention to issues of entrepreneurial cognition (e.g., over-optimism, illusion of control) which may adversely affect borrowing decisions. In terms of the firm performance effects of credit access, the review highlights the widely used internal finance approach to testing financial constraints is unidentified because it is unable to disentangle financial from cognitive constraints. An alternative, more direct, external funding gaps test of underinvestment is therefore proposed. The policy literature is also reviewed which suggests that assistance in the form of loan guarantees has been both finance and economic additional (i.e., providing entrepreneurs with credit they cannot get elsewhere and helping to create jobs that would not otherwise have been created) especially following the Great Financial Crisis. A discussion of the literature relating to underrepresented groups in the entrepreneurial credit market highlights that female and ethnic minority entrepreneurs may receive less credit, and/or pay a higher rate on the credit they receive, than their male or white counterparts. This speaks to ongoing issues of gender stereotypes and ethnic discrimination in the credit market. The increasing role of peer-to-peer lending following the Great Financial Crisis, and its potential for ‘democratizing entrepreneurial finance’, is discussed. This literature highlights that, while peer-to-peer lending is helping to fill credit gaps following the Great Financial Crisis, there are issues relating to the performance of small business peer-to-peer loans and possible issues of ethnic discrimination. The review concludes with proposals for future research on entrepreneurial borrowing, including: collecting more data relating to entrepreneurial credit journeys; developing tests for the presence of information asymmetries and the nature of selection in entrepreneurial credit markets; testing relationships between stages of the entrepreneurial credit journey (e.g., to shed light on the causes of discouragement); developing tests which disentangle financial from cognitive constraints; and researching entrepreneurial and bank learning over recurrent entrepreneurial credit journeys.