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Information Asymmetries in Bank Lending, with the Moderating Effect of Entrepreneurship: a Driver of Equity Crowdfunding

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Information Asymmetries in Bank Lending, with the Moderating Effect of Entrepreneurship: a Driver of Equity Crowdfunding Master’s Thesis International Business & Management June 2020 Information Asymmetries in Bank Lending, with the Moderating Effect of Entrepreneurship: A Driver of Equity Crowdfunding AUTHOR Tiago Lopes (S4015258) SUPERVISOR Dr. A. Kuiken CO-ASSESSOR Dr. M.C. Sestu Word count: 16451 (Excluding title page, table of contents, tables, references, and appendices) Abstract The exponential adoption of equity crowdfunding platforms by SMEs had as its catalyst the Global Financial Crisis in 2008, yet detailed research surrounding the conditions that drive SMEs towards these platforms remains sparse. Much prior research has instead focused on the factors that contribute to a successful campaign on these platforms. By drawing on the pecking order and information asymmetry theory, this paper explores the assertion that when SMEs seek bank credit greater information asymmetries will contribute to a higher amount of equity crowdfunding being raised in that country. Additionally, this research assesses the relationship between the drive towards equity crowdfunding platforms and the level of entrepreneurial activity in a country. One of the first quantitative studies in this area is provided by manually constructing a unique sample gathered from the most used equity crowdfunding platforms in the European Union. The sample consists of firms that have successfully obtained funding via these platforms, across 13 European Union countries between 2014 and 2019. In general, the empirical evidence supports the aforementioned theory. I find that an increase in depth of credit information that banks have on SMEs leads to smaller amounts of equity crowdfunding raised. Moreover, the strength of the legal rights of both banks and borrowers, and the existence of a credit registry are found to have a negative effect on the amounts raised. Finally, it is clear that the more entrepreneurial the country and the higher the amounts of equity crowdfunding being raised, the stronger the effect of all the above-mentioned variables. The implications of such findings for theory and practice are outlined in this paper. Keywords: Bank credit; Entrepreneurial finance; Equity crowdfunding; Information asymmetries; Pecking order; Quantile regression; Regulation; Web scraper 2 Table of contents INTRODUCTION 4 THEORETICAL FRAMEWORK 7 I. CROWDFUNDING 7 (I) EQUITY CROWDFUNDING 8 II. REGULATION 11 (I) BANKS 11 (II) INFORMATION ASYMMETRIES 15 III. HYPOTHESES DEVELOPMENT 19 (I) STRENGTH OF LEGAL RIGHTS 19 (II) DEPTH OF CREDIT INFORMATION AND CREDIT REGISTRY 20 (III) ENTREPRENEURSHIP 22 METHODOLOGY 24 I. SAMPLE 24 II. DATA COLLECTION PROCESS AND SOURCES 27 (I) DEPENDENT VARIABLE 27 (II) EXPLANATORY VARIABLES 29 (III) CONTROL VARIABLES 30 III. VARIABLES 30 (I) DEPENDENT VARIABLE 30 (II) EXPLANATORY VARIABLES 31 (III) CONTROL VARIABLES 33 IV. METHOD OF ANALYSIS 35 RESULTS 38 I. MAIN RESULTS 38 II. ROBUSTNESS TESTS 43 DISCUSSION AND CONCLUSION 45 REFERENCES 49 APPENDIX 58 3 Introduction In recent years, the literature began to focus on the topic of crowdfunding (Habla & Broby, 2019: 3-6), as small and medium-sized enterprises (SMEs) have started to employ this new alternative source of financing. The exponential adoption of crowdfunding and the subsequent interest by scholars on the topic had as a catalyst the Global Financial Crisis (GFC) in 2008. In the aftermath of the crisis, the “brand image of banks and their perceived stability had been shaken to the core” (Arner, Barberis, & Buckley, 2015: 1286) and banks were more averse to concede loans to SME borrowers (Fenwick, McCahery, & Vermeulen, 2018). In essence, the vast governmental post-crisis regulatory responses (Sum, 2016) and the tightening of lending standards (Hempell & Sørensen, 2010) further constrained banks’ lending capacity. In these conditions, SMEs are deemed to be the most vulnerable and affected (OECD, 2012). Information asymmetries play a key role in this condition. Essentially, banks lack the necessary information to delineate a loan contract with SMEs, often due to their opaqueness (Meza & Webb, 1987; Stiglitz & Weiss, 1981). Information asymmetries constrain banks’ lending to these firms for two main reasons. Firstly, when banks increase interest rates, to reduce credit risk, they tend to attract high risk borrowers and alienate low risk firms (Huang, When, & Liu, 2014; Steijvers & Voordeckers, 2009: 925). This effect is called the adverse selection. Thus, when increasing interest rates, banks expected return will decrease (Leland & Pyle, 1977). Ultimately, leading them to prefer to ration credit to these opaque firms. Secondly, moral hazard restrains the provision of credit by banks due to the fear of SMEs not complying with their contract (Binks, Ennew, & Reed, 1992) and the difficulty in monitoring their behaviour (Jenses & Meckling, 1976). In order to minimize the effect of both these information asymmetry issues, banks often make use of collateral (Blazy & Weill, 2013). However, banks are frequently still reluctant to provide credit to SMEs, because these firms tend to have limited assets to collateralize and most of them are intangible (Bădulescu, 2010; OECD, 2020: 78). Overall, the GFC further accentuated the information asymmetries between SMEs and banks, which in tandem with the formers’ lack of collateral and their highly uncertain environment, heavily constrains banks’ lending (Bădulescu, 2010). 4 Crowdfunding platforms started to slowly fulfil the underserved need for credit by SMEs. Hence, bridging the gap which had been left opened by banks (Belleflamme, Lambert, & Schwienbacher, 2014; Gradoń & Cichy, 2015). The pecking order theory (Myers & Majluf, 1984) suggests that firms prefer to obtain funding via equity-based deals when the information asymmetries for debt-based deals (i.e., bank credit) are too high (Bharath, Pasquariello, & Wu, 2009). In this context, equity crowdfunding becomes relevant as it is a novel way to reduce transaction costs. These platforms provide standardized information (e.g., pitch decks) for all the companies listed (Blaseg & Koetter, 2015: 7) and rely on the “wisdom of the crowd” to decide which ventures are the most promising ones (Surowiecki, 2004; Yum, Lee, & Chae, 2012). Additionally, equity crowdfunding attracts investors mainly seeking financial returns, as opposed to more social and artistic oriented platforms (i.e., donation- and reward-based crowdfunding) (Cox & Nguyen, 2018). Thus, it resembles the more traditional financiers, such as banks. When it comes to the literature, equity crowdfunding has been underrepresented (e.g., Mochkabadi & Volkmann, 2020). Scholars, regardless of the changing lending environment, have largely dedicated their attention to assess how SMEs react to tighter credit conditions when it comes to trade credit (e.g., McGuinness & Hogan, 2016; Ogawa, Sterken, & Tokutsu, 2013), leasing (e.g., Kraemer-Eis & Lang, 2014) and factoring (e.g., Mol-Gómez-Vázquez, Hernández-Cánovas, & Koëter-Kant, 2018). Research has also focused on the use by SMEs of business angels (e.g., Ramadani, 2012) and Venture Capital (VC) (e.g., Gompers & Lerner, 2001) funding. However, despite equity crowdfunding being a substitute to VC funding (D’Ambrosio & Gianfrate, 2016), the research output on equity crowdfunding has been far inferior. Research on the different types of crowdfunding has mainly focused on four streams: (1) determinants of a successful campaign (e.g., Belleflamme, Lambert, & Schwienbacher, 2013; Belleflamme et al., 2014; Mollick, 2014), (2) herding behaviour of capital providers and the influence on companies’ funding amount (e.g., Herzenstein, Dholakia, & Andrews, 2011; Kuppuswamy & Bayus, 2018; Lee & Lee, 2012) (3) companies’ motivations to join equity crowdfunding platforms (e.g., Belleflamme et al., 2013) and (4) capital providers’ motivations to fund these companies (e.g., Lin, Boh, & Goh, 2014). Only a frankly small number of scholars have focused on the role of equity crowdfunding in situations of tighter lending conditions for SMEs (e.g., Hornuf & Schwienbacher, 2017; Klöhn, Hornuf, & Schilling, 2016; Pereira, 2017). In general, scholars have failed to acknowledge the importance of equity crowdfunding and the role of information 5 asymmetries has equally been overlooked. Information asymmetries are detrimental for the formation of loan contracts between SMEs and banks. Thus, especially in a time of potentially stricter banking regulations (Binham, 2019), these can further hinder SME’s ability to obtain bank credit (Deakins & Hussain, 1994: 24), illustrated by the rising adoption of equity crowdfunding by European users (Zhang et al., 2018: 41-42; Ziegler et al., 2017). The growing importance of equity crowdfunding, together with its potential benefits, the absence of data and the existing information asymmetries, highlights the research gap (Esho & Verhoef, 2018: 21-22; Habla & Broby, 2019: 6-9). Thus, I address the following research question: How do countries’ information asymmetries between banks and SMEs influence the amounts of equity crowdfunding being raised? To test this claim, a web scraper is used to gather data from 15 equity crowdfunding platforms of 13 European Union (EU) countries for firms between 2014 and 2019. This is then combined with data from The World Bank on countries’ information asymmetry indexes. A quantile regression for panel data with bootstrapped standard errors is employed. This research makes a noteworthy contribution to the pecking order theory and entrepreneurial finance literature. This paper presents
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