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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.

Suggested Citation

  • Ramana Nanda, 2008. "Cost of External Finance and Selection into Entrepreneurship," Harvard Business School Working Papers 08-047, Harvard Business School.
  • Handle: RePEc:hbs:wpaper:08-047
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    File URL: http://www.hbs.edu/research/pdf/08-047.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. Marco Caliendo & Jens Hogenacker & Steffen Künn & Frank Wießner, 2015. "Subsidized start-ups out of unemployment: a comparison to regular business start-ups," Small Business Economics, Springer, vol. 45(1), pages 165-190, June.
    3. William R. Kerr & Ramana Nanda, 2010. "Banking Deregulations, Financing Constraints, and Firm Entry Size," Journal of the European Economic Association, MIT Press, vol. 8(2-3), pages 582-593, 04-05.
    4. William R. Kerr & Ramana Nanda, 2009. "Financing Constraints and Entrepreneurship," Harvard Business School Working Papers 10-013, Harvard Business School.
    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. Hans K. Hvide & Jarle Møen, 2010. "Lean and Hungry or Fat and Content? Entrepreneurs' Wealth and Start-Up Performance," Management Science, INFORMS, vol. 56(8), pages 1242-1258, August.
    7. Ramana Nanda & Matthew Rhodes-Kropf, 2010. "Financing Risk and Innovation," Harvard Business School Working Papers 11-013, Harvard Business School, revised Jan 2014.
    8. Edward L. Glaeser & William R. Kerr, 2009. "Local Industrial Conditions and Entrepreneurship: How Much of the Spatial Distribution Can We Explain?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 18(3), pages 623-663, September.
    9. repec:kap:sbusec:v:49:y:2017:i:4:d:10.1007_s11187-017-9853-y is not listed on IDEAS

    More about this item

    Keywords

    financing constraints; entrepreneurship; entry.;

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups

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