Recent Publications
This paper analyzes the capital budgeting practices of small firms using survey data compiled by the National Federation of Independent Business. Unlike large firms, which tend to rely on the discounted cash flow calculations favored by finance texts, many small firms evaluate projects using the payback period or ‘gut feel’. The use of these relatively unsophisticated project evaluation tools appears to be due in part to the limited educational background of some small business owners, and small staff sizes. However, we also identify specific business reasons—including liquidity concerns and cash flow estimation challenges—why small firms do not exclusively use discounted cash flow analysis when evaluating projects. Thus, our results suggest reasons why optimal investment evaluation procedures for large and small firms might differ.
A Note on Agency Conflicts and the Small Firm Financing Decisions (with Morris Danielson), Journal of Small Business Management, forthcoming January 2007
This paper explains how agency conflicts—and potential agency conflicts—can influence the investment decisions of small firms, and provides evidence of these effects using data from a recent survey of small firm investment practices. The survey asks business owners to identify their most important investment concern—over-investment or under-investment. We find that under-investment concerns are more prevalent in growing firms, and those with concentrated ownership and control structures. Over-investment concerns increase as firms adopt less-concentrated ownership and control structures. These results suggest that the management challenges facing small firms shift as the degree of separation between ownership and control becomes greater.
This paper presents empirical evidence on the role loan officers play in facilitating small firm access to commercial bank loans. If loan officers use soft information (e.g., assessments of character, information from customers and suppliers) to make lending decisions that would not otherwise be made on the basis of hard information (e.g., tax returns or financial statements), then frequent turnover in loan officers should be associated with an adverse effect on credit availability. This relationship is confirmed empirically using survey data of U.S. small firms in 1995 and 2001, where loan officer turnover is positively related to the turndown rate on the most recent loan application. Although loan officer turnover could be influenced by the turndown rate (e.g., an owner changes banks and gets a new loan officer as a result of a recent turndown), its negative effect on credit availability persists under several different tests.
Women-owned businesses are often thought to face difficulties in applying for and securing bank loans (Buttner & Rosen, 1992; Coleman, 2000; Fabowale et al., 1995; Haines, Orser, Riding, 1999; Orser, Hogarth-Scott, & Riding, 1994; Riding & Swift, 1990; Schwartz, 1979). While there may always be individual instances of difficulties with credit availability that might receive the attention of the media, the more important issue – especially given the increasing contribution of women-owned business to growth in the US economy, is whether women-owned businesses face any systemic, non-economic discrimination in applying for credit. We test three questions related to the success of women-owned businesses in accessing commercial bank financing. First, are women-owned businesses less likely to apply for bank loans than businesses owned by men? Second are women-owned businesses more likely to be turned down in their most recent loan application. And finally, if approved on their most recent loan application, are they more likely to receive a smaller loan. We found gender to be related to the application for bank loans as well as the size of the loans but not to the frequency of turn downs.
This paper presents evidence that the expansion in the late 1990s was unusual and should not be used as a basis for benchmarking the output gap at zero. Counting on the economy’s ability to repeat the employment performance of the late 1990s and 2000 may lead to incorrect assessments of the future of the economy and inflation as there may be far less slack in labor markets than our experience in the late 1990s suggests. The unusual psychology of the period and the misguided perception that growth would continue indefinitely led to an abnormal expansion of employment and labor force participation that would not likely reoccur in a more normal business cycle.
This paper investigates the effects of bank loan availability on the trade credit and credit card demand of small firms, using firm-level data from the 1995 Credit, Banks, and Small Business Survey, conducted by the National Federation of Independent Business. We find that firms increase their demand for trade credit and credit card debt when facing credit constraints imposed by banks. These results provide evidence of a pecking order of debt financing, where firms increase their reliance on potentially expensive sources of funds when bank loans are not available.
Forecasting Employment and Inflation: A Small Business-Based Model, Business Economics, 39, (October, 2004), 44-49.
In this paper, we use the responses to the National Federation of Independent Business’ monthly survey of their membership to forecast macroeconomic indicators of employment and inflation. We find that small firm expectations about hiring plans and current job openings are able to explain over 70% of the variation in the national unemployment rate, but are less successful in explaining non-farm employment. Small firm planned prices changes and past price changes are also quite successful in anticipating inflation for a number of price indices.
This paper examines whether community banks have a niche in the production of soft information when lending to small firms. A composite measure of soft information production is created from owner ratings of bank performance characteristics using survey data from a national sample of U.S. small firms. These characteristics capture some important aspects of soft information such as the bank’s knowledge of the owner’s business. This composite measure is related to the size of the owner’s primary bank, a measure of the intensity of market competition and proxies for the strength of banking relationships. After controlling for several sources of endogeneity, this composite measure is found to be significantly higher if the owner currently banks at a CFI and experiences less loan officer turnover.
In this study the effect of bank mergers on the most recent attempt to obtain financing from a sample U.S. small firms in the mid-1990s. Banking mergers, which affected about 25% of the firms responding to the survey, had no significant effect on the ability of small firms to obtain a loan or the contract loan rate on the most recent loan from a commercial bank. However, the incidence of mergers does appear to increase non-price loan terms, increase the incidence of related fees for services, raise the frequency of searching for a new bank, and result in deterioration of service quality. Little evidence is found that the most informationally opaque firms (e.g., the smallest firms) bear a higher cost from mergers than do less informationally opaque firms.
Credit, Banks and Small Business - The New Century: A Research Perspective, April 2003
This paper summarizes the key findings from the 2001 Credit, Banks and Small Business survey, focusing on where the data can provide further understanding to important questions facing small business researchers.
This paper shows how a simple, but powerful, valuation model can extend the scope of valuation analysis to include industry structure and firm strategy considerations. This model can be used by an analyst to quantify the amount of positive net present value investment implied by a firm’s stock price. The reasonableness of these expectations can then be evaluated within the context of the firm’s industry structure and unique competitive advantages. In addition, the paper describes possible classroom applications. Students have the opportunity to better understand how strategic, marketing, production and human resource activities can create value and sustain economic rents with this model. By expanding the scope of valuation instruction with this approach, finance faculty can provide an interdisciplinary perspective that meets the needs of both business stakeholders and the business accreditation standards.
Working Papers
Technology, Banking and Small Business, August 2006
This paper reports on the results of a recent survey of small business owners that addressed the question of technology use in the conduct of their banking business. The analysis focuses on three issues. First, what are the characteristics of owners who use technology in banking? Second, do the characteristics that explain the use of technology also explain their view of technology as an enabler of their banking business or whether technology implementation is being forced upon them? And finally, has technology implementation been disruptive enough to cause owners to shop for a new bank or take the more costly step of changing banks?
Why Do Small Firms Change Banks, April 2006 (to be presented at FMA 2006 Annual Meeting)
This paper investigates why small firms change banks using survey data obtained from a sample of U.S. small businesses. These data are unique because they include the reasons for changing banks (e.g., mergers, loan officer turnover, inadequate credit line) and owner ratings of characteristics important to conducting their banking business (e.g., the bank’s knowledge of their business, location, range of services offered). The primary findings of the paper are: 1) information-opaque small firms unlikely to be held-up by their current bank; 2) the reasons for changing banks are related to how owners rate the relative importance of their relationship versus transactions banking needs; and 3) owners changing banks are located further from their new bank with the least information-opaque firms moving the furthest away.
This paper uses survey data from 1987 through 2001 to analyze whether community banks have a comparative advantage in delivering service quality to small businesses. Service quality is measured using small firm assessment of several attributes related to the closeness of banks to their customers: location, reliability as a source of credit, speed of credit decisions, access to their loan officer, and range of services offered. After controlling for the self-selection of small banks, owners of small firms are found to rate small banks’ service quality better than that of large banks. This conclusion holds over a period characterized by dramatic consolidation within the banking system as well as technological change in the delivery of financial services.
This paper examines how a set of small firm banking outcomes are related to changes in the state of competition among financial institutions. The state of competition is measured by an owner assessment of bank competition for their financial business as well as a traditional measure of deposit concentration. A significant positive association is found between changes in bank competition reported by owners and their reports of changes in service delivery and credit availability, but no association with loan terms. Deposit concentration was not significant in explaining any outcome. The possibility that owners assume that a good outcome is a result of increased competition for their banking business is rejected. Evidence is provided that is consistent with owners recognizing changes in bank competition in their markets regardless of the outcomes experienced.
Entrepreneurial
Firms and Community Banks: Complementary or Conflicting Interests in Banking Relationships,
November 2003
Using responses from over 2,000 members of the National Federation of Independent Business (NFIB) in a recent survey of their financing needs and experiences in 2001, the paper examines the role of soft information versus size as it affects the use of community financial institutions (CFI) by high growth, entrepreneurial firms. Entrepreneurial firms have a clear preference for CFIs based on the quality of their service and their ability to produce soft information about their business. However, entrepreneurial firms at CFIs are less likely to have credit needs satisfied and more likely to pay higher rates. A comparison of non-rate terms between LFIs and CFIs shows a mixed outcome.
Loan Search and Bank Relationships (with M.
Leeds and W. Dunkelberg),
September 2004
A model of loan search is developed where the firm seeks another loan offer if the net gain from search exceeds the reservation loan cost, which is a function of the time preference of the firm, the expected cost of the loan, and the cost of search. A stronger banking relationship reduces the chance that the revealed loan cost from the most recent application will be higher than expected, thus reducing the need for additional search. Survey data from over 2,800 small firms in the United States is used to test the model and all of the key variables are significant.
Return to Dr. Scott's Home Page
Last Update:
06 June 2005 15:50