Financing Constraints and Firm Growth in Emerging Europe

Abstract

Alarmingly, the burgeoning empirical literature on the causes and effects of financing constraints finds considerable and robust evidence that financing constraints severely affect firm behavior, obstruct firm performance and greatly curb firm growth. 1 Theoretically, the presence of financing constraints is ascribed to capital market imperfections such as non-negligible information asymmetries between entrepreneurs and uninformed outside investors. For instance, in the model of credit rationing developed by Stiglitz and Weiss (1981), imperfect information induces banks to resort to rationing credits instead of increasing the interest rate to maximize profits. Since the interest rate banks charge for credits also affects the riskiness of their pool of loans through an adverse selection effect and a negative incentive effect, higher interest rates would both attract riskier projects and induce debtors to realize projects with a generally lower probability of success but higher returns when successful. Hence, the on average higher riskiness of potential borrowers lowers overall profits for the banks and induces profit-maximizing banks to restrict the number of credits they grant.Empirically, a quickly growing body of literature finds strong evidence of financing constraints, but also stresses that the prevalence and extent of such constraints strongly depend on specific firm characteristics. For instance, due to insufficient collateral and resources, smaller firms are more financially constrained Sandra M. Leitner ABSTRACT The paper aims to shed light on the effects of different types of financing constraints on firm sales and employment growth in Emerging

Investigating the Relationship Between Financial Constraint and Growth of SMEs in South Eastern Europe

“…A significant negative association between foreign ownership and firm growth was found. Such result is in line with Leitner (2016), where a negative link between foreign ownership and both sales and employment growths was found in NMS-10, Turkey, and Western Balkan economies. First, although it may have been possible for foreign-owned SMEs to satisfy their financial need for growth, they may have preferred not to grow due to other factors, such as limited market opportunities, administrative and legal constraints, or macroeconomic and political instabilities in the selected developing countries.…”

“…Apart from that, Regasa, Roberts, and Fielding (2017) evidenced a negative relationship between access to external financing and SME growth in Ethiopia. Furthermore, it is also documented that more advanced economies with larger banking systems and liquid equity markets allow firms to grow faster (Demirgüç-Kunt & Maksimovic, 1998), whereas in economically less developed countries, financing obstacles, especially high interest rates, collateral requirements, and bureaucracy are detrimental to the growth of SMEs (Hashi, 2001;Leitner, 2016). Hashi and Krasniqi (2011), employing ordinary least squares (OLS) regression and using data from the Business Environment and Enterprise Survey (BEEPS) in cases of three Central European (Poland, Hungary, Czech Republic) and three SEE countries (Albania, Macedonia, Serbia, and Montenegro), argued that differences in access to external financing between country groups were related to the growth stages of SMEs and levels of institutional development.…”

“…The authors concluded that compared with large firms, SMEs are more financially constrained, relying mostly on internal financial sources because their loan applications are more likely to be refused. Leitner (2016) investigated the impact of financial obstacles and other control variables on growth of SMEs in the NMS-10, Turkey, and Western Balkan economies in pre-and post-financial crisis. The findings emphasize that financial obstacles were more detrimental to the employment growth of SMEs in the Western Balkans than in the NMS-10 economies and Turkey.…”

“…Among other obstacles, collateral requirements, bank paperwork and bureaucracy, the need for special connections with bank officials, and interest rates are the greatest impediments to the growth of SMEs, more so than to the growth of large enterprises . What is more significant, financial obstacles hamper both the employee and asset growth of Albanian (Hashi, 2001) and all of the Western Balkan SMEs more than those of their established counterparts in more developed economies (Leitner, 2016).…”

“…Second, unlike the descriptive comparison of firm characteristic patterns in the financing constraints of SMEs among Western Balkan countries by Musta (2017b), our analytical methodology is of an empirical nature. Third, Hashi and Toçi (2010) analyzed only the firm-specific determinants of financing constraints for all SEE countries and Leitner (2016) focused on the association between financing constraints and SME growth in cases of 10 New Member States (NMS-10) of the EU, Turkey, and the Western Balkans, whereas we investigate both firm-and country-specific determinants of SME financial obstacles and examine the effects of financing constraint on firm growth in the selected non-EU member SEE economies (Albania, Bosnia and Herzegovina, Macedonia, Montenegro, Serbia, and Kosovo) or Western Balkans only. Referring to the sample of selected economies, we argue that due to the differences in financial infrastructure; regulatory, administrative, and business environment; and other factors, SMEs in EU member and nonmember states have different growth obstacles and opportunities.…”