What Affects New and Established Firms’ Expansion? Evidence from Small Firms in Russia

Abstract

Research on financial constraints of very small firms is scarce because it is difficult to observe and measure their transactions. Previous studies on small enterprises in post-communist countries have focused either on the effect of financing constraints on business growth (Budina et al., 2000, Economics of Transition8(2), 453–475; Bratkowski et al., 2000, Economics of Transition8(1), 101–116) or on the effect of property rights (Johnson et al., 2002, American Economic Review92(5), 1335–1357). This paper provides evidence on both. It turns out that financing constraints and property rights considerations affects investment in firms of different age differently. Younger firms face higher information costs and their expansion is more dependent on the availability of internal funds than is the expansion of older firms. This paper also finds that while the financial sector did not channel funds to the most successful businesses, there is evidence that loans were given to firms that had more transparent transactions. Results also indicate that the security of property rights does not influence investment in young firms, which is interpreted to mean that only the most efficient entrepreneurs entered the market. In older small firms, investment is negatively influenced by the index of security of property rights suggesting that these firms might have “secured” their property rights by bribes. Improvements in the security of property rights, therefore, would help more micro enterprises to be born as well as decrease transaction cost of established enterprises.