Monitoring Costs, Credit Constraints and Entrepreneurship
AbstractThe vast majority of firms in developing economies are micro and small enterprises owned by families whose members also provide the labour to the units. Often, they fail to grow in size even with the relaxation of credit constraints. In this paper, we show that frictions in the labour market leading to monitoring costs tend to reduce the growth of the firm via two channels: (1) it forces the entrepreneur to devote more time on monitoring hired labour from outside family which curtails her time on productive activities leading to failures of firm's projects. (2) The need to pay a premium wage over the market rate in order to incentivize workers makes it costlier for the firm to expand in size via hiring outside labour. In this framework, we show that possibility of an inverted U- shaped relationship between the credit supply and the size of the firm, measured by hiring of non family labour, indicating frictions in the labour market may outweigh the effects of the easing of borrowing constraints of the firm. We then use a unique data-set comprising large nationally representative surveys of small and micro-enterprises in Indian manufacturing and find support for the existence of such a non-monotonic relationship attributed to both frictions in the credit and labour markets.
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Bibliographic InfoPaper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 6594.
Length: 27 pages
Date of creation: May 2012
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Find related papers by JEL classification:
- D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-06-25 (All new papers)
- NEP-BEC-2012-06-25 (Business Economics)
- NEP-ENT-2012-06-25 (Entrepreneurship)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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