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A Trojan horse or the golden fleece? small business investment companies and government guarantees

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  • Elijah Brewer, III
  • Hesna Genay
  • William E. Jackson, III
  • Paula R. Worthington
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    Abstract

    Profitability is a central concern when governments provide guarantees to increase the flow of funds to disadvantaged groups. We examine the profitability of small business investment companies (SBICs) that are chartered and regulated by the U.S. Small Business Administration (SBA) to finance the activities of small firms. We document, over the 1986-91 period, dismal performance by SBICs. Because SBICs have access to government-guaranteed funds, financial distress among SBICs can expose the SBA, and hence taxpayers, to losses. Using two alternative sample selection models, we examine the relationship between SBICs’ use of SBA funds and returns on equity (ROE) and survival probabilities. The first sample selection model is based on a model of failure/survival. The second selection model is based on our observation that many SBICs do not take advantage of SBA leverage: nearly one-third of SBICs use no leverage at all, and that figure rises to three-fifths for bank-owned SBICs. The results from our sample selection models indicate that SBA leverage--the amount of funds borrowed from the SBA as a percent of private capital--reduces ROE and the probability of survival. In addition, we find that the probability of using SBA leverage decreases for bank-owned SBICs relative to other SBICs and for highly profitable and efficient SBICs, while it increases for SBICs using debt to finance the activities of small firms. Thus, our results suggest that an SBIC’s performance is negatively correlated with SBA leverage.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series, Issues in Financial Regulation with number WP-97-22.

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    Date of creation: 1997
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    Handle: RePEc:fip:fedhfi:wp-97-22

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    Related research

    Keywords: Small business;

    References

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    1. Berger, Allen N, 1995. "The Profit-Structure Relationship in Banking--Tests of Market-Power and Efficient-Structure Hypotheses," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 404-31, May.
    2. Holtz-Eakin, Douglas & Joulfaian, David & Rosen, Harvey S, 1994. "Sticking It Out: Entrepreneurial Survival and Liquidity Constraints," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 53-75, February.
    3. Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "Determinants of commercial bank interest margins and profitability : some international evidence," Policy Research Working Paper Series 1900, The World Bank.
    4. Allen N. Berger, 1994. "The relationship between capital and earnings in banking," Finance and Economics Discussion Series 94-2, Board of Governors of the Federal Reserve System (U.S.).
    5. Jacobson, Robert, 1987. "The Validity of ROI as a Measure of Business Performance," American Economic Review, American Economic Association, vol. 77(3), pages 470-78, June.
    6. Ronen, Joshua & Sorter, George H, 1972. "Relevant Accounting," The Journal of Business, University of Chicago Press, vol. 45(2), pages 258-82, April.
    7. Lynch, Lisa M, 1992. "Private-Sector Training and the Earnings of Young Workers," American Economic Review, American Economic Association, vol. 82(1), pages 299-312, March.
    8. Elijah Brewer, III & Hesna Genay & William E. Jackson, III & Paula R. Worthington, 1996. "Performance and access to government guarantees: the case of small business investment companies," Economic Perspectives, Federal Reserve Bank of Chicago, issue Sep, pages 16-32.
    9. James J. Heckman, 1976. "The Common Structure of Statistical Models of Truncation, Sample Selection and Limited Dependent Variables and a Simple Estimator for Such Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 5, number 4, pages 475-492 National Bureau of Economic Research, Inc.
    10. Robert B. Avery & Gerald A. Hanweck, 1984. "A dynamic analysis of bank failures," Research Papers in Banking and Financial Economics 74, Board of Governors of the Federal Reserve System (U.S.).
    11. Benston, George J, 1985. "The Validity of Profits-Structure Studies with Particular Reference to the FTC's Line of Business Data," American Economic Review, American Economic Association, vol. 75(1), pages 37-67, March.
    12. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
    13. Elijah Brewer, III & Hesna Genay & William E. Jackson, III & Paula R. Worthington, 1996. "Performance and access to government guarantees: the case of small business investment companies," Proceedings 524, Federal Reserve Bank of Chicago.
    14. Elijah Brewer, III & Hesna Genay & William E. Jackson, III & Paula R. Worthington, 1996. "The security issue decision: evidence from small business investment companies," Working Paper Series, Issues in Financial Regulation WP-96-27, Federal Reserve Bank of Chicago.
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