Financial Frictions, Cyclical Fluctuations and the Innovative Nature of New Firms

Christoph Albert and Andrea Caggese

No 815, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: How do financial factors and cyclical fluctuations affect the innovative content of new businesses? This paper answers this question by combining a multi-country entrepreneurial level dataset with country level business cycle data and sector level information on technology. Our main data source is the Global Entrepreneurship Monitor dataset, which is a multi-country multi-year survey of entrepreneurial decisions. We merge this dataset with a country specific business cycle indicator (GDP growth) and a financial crisis indicator from Laeven and Valencia (2013). Finally, we also combine it with two sector level indicators: an external financial dependence indicator (Kroszner et al, 2007) and an indicator of intangibility (share of intangible over total assets, see Falato et al, 2014, and Caggese and Perez, 2018). We use the dataset to identify three types of startups which are likely to be innovative and/or with high growth potential: i) Businesses started to provide a new product or service. ii) Startups for which the new entrepreneur is expecting high employment growth (controlling for country effects). iii) Startups in high-intangible industries, which should have higher growth potential given the more innovative content of intangible technologies. We control for country fixed effects, as well as for individual characteristics such as age, education and income group, and we find that all startups, but especially startups with high growth potential, were much more procyclical in the presence of the financial crisis. That is, the financial crisis reduced significantly more startups with high growth potential than the other types, especially in countries with greater contraction in output. Importantly we also show that startups with high growth potential were strongly negatively affected by the financial crisis only in industries classified as with high external financial dependence. In other words, we find evidence strongly consistent with the hypothesis that financial frictions affected the composition of business startups during the financial crisis, reducing the incentives of entrepreneurs to start riskier and more innovative businesses with more growth potential.

Date: 2018
New Economics Papers: this item is included in nep-ent, nep-ino, nep-mac and nep-sbm
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