Business & Economics Research by Korosteleva and Mickiewicz

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The research study on property rights, formal and informal financing options and their relationship to start-up businesses by Korosteleva and Mickiewicz is an attempt by the authors to find out how factors like property rights protection, financial development and individual characteristics of entrepreneurs determine the entrepreneurial decisions taken during start-ups. In this respect, the research mainly examines the business environment and individual characteristics of entrepreneurs themselves, which determine and affect the financial choices during start-up ventures. The authors Korosteleva, J. and Mickiewicz, T. jointly examine the choice of start-up financing decisions made by entrepreneurs, based on their study of the surveys of various countries as per the Global Entrepreneurship Monitor 1998-2003 report. They examine factors like property rights, financial environment, and individual traits of entrepreneurs like education levels, wealth that they possess, experience in their field of enterprise and social capital that affect such entrepreneurial financing decisions during start-ups. In the process, they consider both formal and informal sources of start-up finance, unlike most other studies, which focus on formal means of finance to raise their initial capital and postulate eight hypotheses, which they arrive at on the basis of their study and empirical analysis. This paper critically analyses their research and attempts to highlight the perceived shortcomings as also tries to effect a personal viewpoint on the study, its methodology and research outcomes.

An Overview of the Research Objective, Methodology & Outcome

The research is primarily concerned with the examination of the business environment and individual characteristics of entrepreneurs themselves, which determine and affect the financial choices during start-up ventures. More specifically, the authors Korosteleva, J. and Mickiewicz, T. jointly examine the choice of start-up financing decisions made by entrepreneurs and base their research on the surveys of various countries as per the Global Entrepreneurship Monitor 1998-2003 report. They also examine the factors like property rights, financial environment, and individual traits of entrepreneurs like education levels, wealth that they possess, experience in their field of enterprise and social capital that affect such entrepreneurial financing decisions during start-ups. In their research, the authors consider both the formal and informal sources of start-up finance, unlike most other studies, which focus on formal means of finance to raise their initial capital. They postulate eight hypotheses as to their findings, which they arrive at on the basis of their study, and these comprise the main issues that they attempt to prove through such study.

Their first hypothesis states that weak property rights in a country tend to constrain external finance that is made available for start-ups. Such external sources may be either informal or formal and both their share in the capital and volume of finance is affected. The second mentions a perhaps obvious fact, which is that entrepreneurs tend to be put off by complex laws and regulations that restrict or constrain business entry into the country concerned. Third, they also find a link between the social capital of entrepreneurs and their success in obtaining external finance. Fourth, they stress the positive effect of financial regulation which can improve finance volumes although at higher levels, they observe, increased regulation does point to a decreasing volume of finance during start-ups. Fifth, they find a link between financial sector development and savings, which in turn goes to provide more capital for start-up projects. In their sixth hypothesis, they stress the necessity of informal channels of finance to be improved, since they perceive that formal channels are not as readily available to entrepreneurs for a variety of reasons. Seventh, they relate high-growth projects to the larger volume of start-up capital required which necessitates more external funding for the entrepreneurial project during the start-up stage. Last and eighth, the differences in socio-economic conditions and individual characteristics that define different entrepreneurs and their start-up activity explain the variances in financing choices, volumes, etc

For proving their hypothesis, the authors rely on data from the stated GEM survey of the years 1998 to 2003 which sourced adult population samples taken from as many as 41 countries. The sample size in this survey is over 2000 and comprises of persons of working ages. The authors actually base their results on the study of start-up or nascent entrepreneurs as the GEM criteria of business definition, which defines a start-up entrepreneur as an individual between the ages of 16 and 64 years, and who exhibit inclination towards setting up a new business venture, owned by them either wholly or partly. The age of the enterprise studied necessarily is less than three months i.e. wages paid out by the new entrepreneurs studied is in no case over three months and which the GEM defines as such. The research also borrows on some intrinsic advantages of a system of survey as followed by GEM. However, the authors use the country-specific measures for macroeconomic as well as institutional development as affecting start-up ventures in each country. In this respect, they chose the Heritage Foundation institutional indicators and the World Bank Development Indicators for incorporating macro-economic control variables into their research. The Heritage Foundation Indicator gives the property rights variables whose values indicate the level of protection of property rights given by law of the country to individual entrepreneurs. Such law also affords protection against appropriation by the state of the property acquired for start-up ventures in that country which contributes to perception of the entrepreneur on the viability and prospects of doing business in that country. The study also uses another Heritage Foundation Index, namely the Financial Freedom index that measures the degree of financial freedom in a country as also the level of state intervention and financial regulation prevalent. A third index used and as mentioned earlier, is the indicator for the extent of financial regulation as derived from the World Bank Country Development studies. A fourth index used is also the Business Freedom Index of the Heritage Foundation, which indicates the level of barriers to business start-up, operations and exit in a particular country.

The authors, in order to make their study more representative and realistic have also introduced the GDP annual growth rate and the GDP per capita (based on PPP) to stress the cyclical effect on start-up entry and financing modes available. In addition, they consider informal institutional investors and their rate of prevalence, as also some dummy variables relating to the results of start-up growth contributors, multi-owner start-ups, the experience of the entrepreneur as a business angel in the past and social network effects on start-ups, among variables. In addition to the independent control variables, the authors also define the dependent variables for depicting the various financing options. As a final measure of robustness check, they introduce four other measures of external funding, funding from non-family, funding from external institutions, and capital sourced from banks and other FI s. Estimators used by the authors include the Tobit and Tobit-II, the Heckman Selection and the Robust Regression Robustness estimators as per the STATA software.

Based on above models, the authors obtain some definite results of study. In particular, they mention the result of the Heckman or Tobit-II results, which seem to indicate that the degree of protection given to property rights in a country is conducive for development of external finance options for an entrepreneur in that country. An important observation they make based on related empirical results is that while the level of property rights protection does not significantly predicate the extent of entrepreneurship in a country, weak property rights do impact the quality of the entrepreneurship, which in turn affects the economic benefits of entrepreneurship. The results also indicate the comparatively higher significance of informal modes of finance as compared to formal finance methods on the development of entrepreneurship and its economic benefits. Informal finance option is seen to be the more attractive in as much as these are less costly and characterized by more symmetrical information sharing. Also, the study finds that socio-economic characteristics like age, sex, wealth and human capital do contribute towards building up a strong capital structure by availing self-finance options or external capital sources, or even both for making their start-up a success. While the formal financing modes are sustained by bank and institutional finance, which are supported by, strong property rights measures; the informal finance methods are better driven by personal wealth, growth factors and multiple ownership structures of the start-ups.

Theoretical Assumptions behind Research: A Critical Analysis

The authors have derived their results and explained their hypothesis by relating to some available literature on the subject. A major plank on which they build up their hypothesis is the GEM data and they have provided some reasonably supportive arguments for such use in their study. While new businesses and entrepreneurs obviously find it hard to obtain finance during start-up, the exact link between property rights in a country and the availability of start-up finance is not so obvious although factors like the prevalent legal regulations, business environment, social conditions, state of the national economy, governmental support to new businesses, etc have been studied by numerous authors with varied results. The study assumes the importance of information asymmetry, which limits the finance made available by investors, particularly in case of start-ups where such projects usually have no record of credit history, and owing to the risk envisaged. While modern financial management does rely to a large extent on risk analysis and the ability of the investor to effectively select from the options available for investment of capital, the author’s assumption that start-ups being exposed to information asymmetry are most probably subject to the pecking order theory as proposed by Myers and Majluf (1984) is not so obvious. Thus the authors’ conjecture that firms when exposed to information asymmetries rely more on cost-effective finance options, needs to be substantiated by relevant research and is at best a loose link. While start-ups have been shown to use their own sources of funds during entry, and also use information rather than formal sources of finance (Bygrave 2003, Huyghebaert 2001), the authors’ contention that entry-level businesses select informal over formal finance modes, internal over external finances, and short term finances over long term finances, does not obviously point to the effect of informational asymmetries in their such selections. They rightly quote Johnson et al. (2002), Van Stel et al (2007), and Ho and Wong (2007) who maintain that formal and informal financial institutions impact the development of entrepreneurship. Johnson (2002) et al in particular state that the development of property rights regulation in a country is a significant determinant of entrepreneurship success in as much as financial choices available to start-ups are restricted by low investment levels caused by the perceived negative nature of business environment. In view of this, the heritage Foundation Property Rights Index, which is a measure of the degree of legal protection to the investors and entrepreneurs, appears to be an appropriate index in the context of the research methodology and outcome.

Another research quoted by the authors is that of Van Stel et al (2007) who maintain that firms perceive minimum capital requirements for entering a national business environment and labor inflexibility as inhibitors for entry of new firms in the market. Since a new firm is driven primarily by its cost considerations and its available resources, including capital and labor, and also because this study considers GEM data samples, its outcomes as relating to the study under analysis may be the subject of critical scrutiny and also does not preclude the existence of an intrinsic bias in the authors’ research approach. Again, the authors quote Beck et al (2005) who have noted a link between the development of financial institutions and their benefits to the business firms. Becket all maintain that the financial environment favors small rather than large firms, but the authors’ argument that the size of the start-up or entry-level firm likewise relates to the developmental state of a nation’s financial system is only a conjecture and perhaps constitutes a weak link at best. The supposed linkage between the availing of external financing options by entry-level firms during start-up and the size of the firm is even more nebulous, although studies by Beck et al (2005), and Demirgüç-Kunt and Maksimovic (1998) do point to the positive relationship between the firm’s financing and expansion on the one hand and the state of development of the financial system on the other hand. Another observation of the authors that social networks play a significant role may be admissible as per available literary evidence. But to state that social networks gain prominence when formal structures do not function properly without relevant research linking formal financing to social networks renders their arguments weak. However, it can be agreed upon when they state that social capital does facilitate more finance by way of increased share and volumes, and as shown by Aldrich et al (1987), and Johannisson (2003).

An assumption, on which the authors base their fourth hypothesis, concerns the banking sector. The authors assume that when financial regulation is more efficient, the banks function more qualitatively. This is open to debate and needs to be substantiated through appropriate citations from relevant literature, particularly that relating to the banking environment, which topic is beyond the scope of their study. Also, it does not follow automatically that banks may finance small and start-up concerns more than they do the large ones once the quality of banking results through efficient financial regulation. More jarring in their research is their adoption of such terms as ‘easy’ and ‘difficult’ for describing banks’ options for investing their funds, and it does not at all make sense either that banks find it ‘easier, to finance large and well-established firms or that they fight shy of small and start-up concerns only because they find this ‘difficult’. The authors, in this respect, have not considered the major issue behind banks’ and other investors’ choice of investment avenues, viz., the need of the capital-heavy investor to retain or improve depleting revenue margins through judicious investment of the funds available, the existing competition that restricts such optimum utilization of funds and above all, in the new business and financial environment, the need to manage all kinds of risks. Accordingly, their hypothesis that financial regulation would necessarily mean more start-up finance is faulty and needs no examination of quantitative outcomes of the research unless the basic hypothesis can be adequately supported by assumptions as reinforced by available literature on the subject. The weakness of the authors’ arguments can also be perceived in the lead-up to their fifth hypothesis when they state that financial development can contribute to capital accumulation via better deposit rates and lower lending rates. If development could be synonymous with consumer culture, then instead of accumulating savings, as seen in many developed and developing countries, the propensity for accumulation of luxury items is seen to increase and in fact, more and more luxury items come to be regarded as essential goods. Also, simply lowering the lending interest rates or increasing bank deposit rates can not by itself drive economic growth unless the surplus funds so released for investment are channeled for further multiplication of the funds, either by way of more deposits or by way of increased advances driven by lowered lending rates. A better financial regulation, therefore does in no way indicate – it may at best imply – that there will be increased savings and even in case of increased savings, it also does not indicate that more funds are available for entrepreneurial projects.

This paper would like to go with the views of the authors of the study under consideration in respect of data consistency, reliability etc are concerned. For one thing, the Global Entrepreneurship Monitor Report as published over the years is a respected and much relevant report. It is a report brought out as part of an international project comprising jointly of the Babson College, USA and the London Business School, UK and also includes forty national teams across the world. Thus the reports are quite representative and reliable. The data collected through GEM survey of adult working-age population, during the period 1998-2003, collecting as many as 2000 samples per country and covering around 41 nations worldwide is truly representative. The authors thereby, and in their own words, avoid bias in samples collected, and the survey method is a direct and primary method where the questions were formulated and competed by inviting answers through phone calls made to the various respondents. The primary research also included face-to-face interviews in case of nations having low phone concentrations. In addition, such a survey also affords an opportunity for cross-national comparison as also clearly defines an entrepreneur as one already trying to establish a new business or start-up. The GEM survey denotes an entrepreneur as one between 16 and 64 years of age, just starting the business and having paid only paid wages or salaries for only the last three months or less. The GEM data also painstakingly collects and provides various individual characteristics of individual entrepreneurs spanning various countries. As per the authors themselves, the GEM survey has on offered various data relating to age, sex, experience, social capital, all linked to particular entrepreneurs as also provides data on growth opportunities and firm ownership structures, informal finance statistics, etc. The authors have tried to use various dependent and control variables to preclude bias from creeping in their results. In addition to the GEM report, they also use different country-specific measures of institutional and economic development, as also other indices like the World Bank Development indicators for macroeconomic control variables, the Heritage Foundation indicators for institutions, the Heritage property Rights indicator, which measures the extent of freedom to retain and utilize property in a country by entrepreneurs, the ratio of domestic credit to the private sector to the GDP as taken from the World Bank Report, and the Heritage Foundation Financial Freedom Index among others.

For their measurement, the authors use estimators like the Heckman selection models, the probit, Tobit and robust regression estimators. An advantage of the Heckman selection model is that it uses the entire survey characteristics for estimating a sample selection. To minimize errors of the Heckman model, the authors also introduce the Tobit standard, with censoring of dependent financing variables, while the robust regression model improves the robustness checking by including continuous variables with no censoring as programmed by the STATA statistical software for better approximation of results.


The authors conclude from their research that property rights need to be a basic criterion for defining an institutional environment and are perceived by them as a determining factor for affecting the level and volume of external finance available for start-up projects. The better property rights are protected, the better the financing options and volume of finance. They also perceive variations in finance from family and friends as relating to the degree of property rights protection as inelastic. This is perhaps readily acceptable. What is not so acceptable is the authors’ view that poor protection of property rights restrains non-family investors and formal financing institutions like banks from lending their funds to the new entrepreneurs. Banks and other investors lend their funds for obtaining returns on their capital so invested. As can be easily ascertained from a study of common banking practices, banks lend their funds based on their risk perception and the mandatory prudential norms that they need to adhere to in the country of operations. In fact, risk management has come to be an integral part of various institutions, including banks and financial concerns. In particular, banks lend their funds and rely on the regular returns on these lent funds by way of interest earned on advances. If at all property becomes a factor in their scheme of doing business, it is only to cover the risk on an advance by mortgaging the borrower’s or guarantor’s property. It is only a second line of defense against loan default and perhaps only a small portion of even chronically bad loans are recovered through sales of mortgaged property. Taking recourse to legal avenues is always complex for the ordinary investor and business concern. This is true in most countries. Entrepreneurial talent is only partly correlated with personal wealth. The authors also observe that the low volumes of formal and informal finance made available to start-ups cannot be fully explained. They opine that the reasons may lie in the nature of national regulatory regimes and the financial development may be depressed in cases of both over-regulation and under regulation. While their contention that regulation needs to be appropriate for new business enterprises to enter a country for doing business, their view that startups are perceived as risky and demanding and hence prevent investors like banks from financing their enterprise needs further elucidation and should be supported by relevant literature in this regard to make their research conclusive and more relevant. This author would like to believe that the very assumptions and direction of research needs a rethink rather than a critical analysis of choice of methodology attempted.


Aldrich, H., B. Rosen and W. Woodward (1987) The Impact of Social Networks on Business Funding and Profit. Frontiers of Entrepreneurship Research (Wellesley, MA: Babson College)

Bygrave, W. “Financing Entrepreneurs and their Ventures” in Reynolds, P., W. Bygrave and E. Autio (eds.) Global Entrepreneurship Monitor 2003 Global Report, Kansas City: Kauffman Centre for Entrepreneurial Leadership at the Ewing Mario Kauffman Foundation

Demirgüç-Kunt, A. and V., Maksimovic (1998) “Law, Finance, and Firm Growth”, Journal of Finance 53, pp. 2107-2137

Ho, Y. And P. Wong (2007) “Financing, Regulatory Cost and Entrepreneurial Propensity”, Small Business Economics, 28, 187-204

Huyghebaert, N. (2001) “The Capital Structure of the Business Start-ups: Determinants of Initial Capital Structure”, Review of Banking Finance”, 2, pp.84-88

Johnson, S., J., McMillan and C., Woodruff (2002) “Property Rights and Finance”, the American Economic Review, Vol. 92, No.5, pp. 1335-1356

Johannisson, B., (2000) “Networking and Entrepreneurial Growth”, in D. Sexton and H. Lawrence (Eds), the Blackwell Handbook of Entrepreneurship Blackwell: Oxford, pp. 368-386

Myers, S. and N., Majluf (1984) “Corporate Financing and Investment Decisions When Firms have Information that Investors do not have”, Journal of Financial Economics 13(2), 187-221

Van Stel, A., D., Storey and R., Thurik (2007) “The Effect of Business Regulations on Nascent and Young Business Entrepreneurship”, Small Business Economics, 28, pp. 171-186

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