Cognitive financial constraints and firm growth

Jun Du,Bach Nguyen

doi:10.1007/s11187-021-00503-7

Abstract

This study distinguishes entrepreneurs’ cognitive financial constraints from financial supply constraints and assesses their relative importance to small business growth. Drawing from the literature on cognitive styles and institutional theory, we argue that small businesses’ financial constraints derive not only from financial market failures but also from the cognitive factors of entrepreneurs. Analysing a comprehensive dataset of more than 200,000 small businesses in Vietnam, we show that both financial supply and cognitive financial constraints impede firm growth. Given this significantly deleterious effect, the cognitive financial constraints originating from the demand side of firm financing deserve more attention.

Highlights

Few small businesses can obtain bank loans that are sufficient for their investment needs (Carreira & Silva, 2010)
We examine the extent to which cognitive financial constraints affect small firm growth. While both financial supply constraints and cognitive financial constraints have a negative impact on firm growth, we argue that a reduction in cognitive financial constraints gives rise to a higher growth rate than that which is generated by a reduction in financial constraints
Given that the nature of cognitive financial constraints is largely unexplored (Fraser et al, 2015), the relative importance of financial constraints and cognitive financial constraints remains unknown. Even though it has been well-documented in the extant literature that financial supply constraints shackle young and small businesses, we propose that cognitive financial constraints may play an even more pronounced role in the long-term growth prospect of small- and mediumsized enterprises (SMEs)

Summary

Introduction

Few small businesses can obtain bank loans that are sufficient for their investment needs (Carreira & Silva, 2010). This issue, known as financial constraints, originates from market failures caused by informational asymmetries, adverse selection, and moral hazard (Bond & Meghir, 1994). Finance forces entrepreneurs to scale down their investments in line with the funding that is available and affordable; this is generally suboptimal, which hampers their growth (Guariglia et al, 2011) While this funding gap has been addressed in existing studies, there is another funding gap that is less familiar but which contributes to the binding of the growth of small businesses.

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