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Cost of External Finance and Selection into Entrepreneurship

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  • Ramana Nanda

    ()
    (Harvard Business School, Entrepreneurial Management Unit)

Abstract

This paper examines the extent to which the positive relationship between personal wealth and entry into entrepreneurship is due to financing constraints. I exploit a tax reform and use unique micro-data from Denmark to study how exogenous changes in the cost of external finance shape both the probability of entering entrepreneurship and the characteristics of those who become entrepreneurs. As expected, differences-in-differences estimates show that the entry rates for individuals who faced an increase in the cost of finance fell by 40% relative to those whose cost of external finance was unchanged. However, while some of the fall in entry was due to less wealthy individuals with high human capital (confirming the presence of financing constraints), the greatest relative decline in entry came from individuals with lower human capital, many of whom were above median wealth. This finding suggests that an important part of the positive relationship between personal wealth and entrepreneurship may be driven by the fact that wealthy individuals with lower ability can start new businesses because they are less likely to face the disciplining effect of external finance.

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Bibliographic Info

Paper provided by Harvard Business School in its series Harvard Business School Working Papers with number 08-047.

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Length: 34 pages
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:hbs:wpaper:08-047

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Related research

Keywords: financing constraints; entrepreneurship; entry.;

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References

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Citations

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Cited by:
  1. William Kerr & Ramana Nanda, 2009. "Financing Constraints and Entrepreneurship," NBER Working Papers 15498, National Bureau of Economic Research, Inc.
  2. Kerr, William R. & Nanda, Ramana, 2009. "Democratizing entry: Banking deregulations, financing constraints, and entrepreneurship," Journal of Financial Economics, Elsevier, vol. 94(1), pages 124-149, October.
  3. William R. Kerr & Ramana Nanda, 2009. "Banking Deregulations, Financing Constraints and Firm Entry Size," Harvard Business School Working Papers 10-010, Harvard Business School, revised Oct 2009.
  4. Edward L. Glaeser & William R. Kerr, 2008. "Local Industrial Conditions and Entrepreneurship: How Much of the Spatial Distribution Can We Explain?," NBER Working Papers 14407, National Bureau of Economic Research, Inc.
  5. Steffen Andersen & Kasper Meisner Nielsen, 2012. "Ability or Finances as Constraints on Entrepreneurship? Evidence from Survival Rates in a Natural Experiment," Review of Financial Studies, Society for Financial Studies, vol. 25(12), pages 3684-3710.
  6. Ramana Nanda & Matthew Rhodes-Kropf, 2010. "Financing Risk and Innovation," Harvard Business School Working Papers 11-013, Harvard Business School, revised Jan 2014.
  7. Jing Chen, 2008. "Wealth Constraints and Self-Employment: Evidence from Birth Order," Working Papers 0808, Florida International University, Department of Economics.

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