Journal of Economic

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Advanced market economies are characterized by a continuous process of creative destruction. Market forces and technological developments play a major role in shaping this process, but institutional and policy settings also influence firms ’ decision to enter, to expand if successful and to exit if competition becomes unbearable. In this paper, we focus on the effects of financial development on the entry of new firms and the expansion of successful new businesses. Drawing from harmonized firm-level data for 16 industrialized and emerging economies, we find that access to finance matters most for the entry of small firms and in sectors that are more dependent upon external finance. This finding is robust to controlling for other potential entry barriers (labor market regulations and entry regulations). On the other hand, financial development has either no effect or a negative effect on entry by large firms. Access to finance also helps new firms expand if successful. Both private credit and stock market capitalization are important for promoting entry and post entry growth of firms. Altogether, these results suggest that, despite significant progress over the past decade, many countries, including those in Continental Europe, should improve their financial markets so as to get the most out of creative destruction, by encouraging the entry of new (especially small) firms and the post-entry growth of successful young businesses.

We study the determinants of vertical integration in a new data set of over 750,000 firms from 93 countries. We present a number of theoretical predictions on the inter-actions between financial development, contracting costs, and the extent of vertical integration. Consistent with these predictions, contracting costs and financial devel-opment by themselves appear to have no effect on vertical integration. However, we find greater vertical integration in countries that have both greater contracting costs and greater financial development. We also show that countries with greater contract-ing costs are more vertically integrated in more capital-intensive industries. CASUAL EMPIRICISM SUGGESTS THE PRESENCE OF SIGNIFICANT differences in the orga-nization of production across countries. For example, firms are often thought to be larger and more vertically integrated in less developed countries. Khanna and Palepu (1997, 2000) provide evidence consistent with this view and suggest that this is because market and contractual relationships are more costly in less developed countries. Nevertheless, there has not been a systematic analysis of

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We evaluate the consequences of a recent regulatory reform in Portugal, which substantially reduced the cost of firm entry. Our analysis uses matched employer-employee data, which provide unusually rich information on the characteristics of founders and employees associated with new firms before and after the reform. We find that the short-term consequences of the reform were as one would pre-dict with a standard economic model of entrepreneurship: The reform resulted in increased firm formation and employment, but mostly among marginal firms that would have been most readily deterred by existing heavy entry regulations. These marginal firms were typically small, owned by relatively poorly-educated entrepreneurs, and operating in low-tech sectors (agriculture, construction, and retail trade). In comparison to firms that entered in the absence of the reform, these marginal firms were less likely to survive their first two years. Government regulation of firm entry can serve to protect insider interests and hold back entrepreneurship. Many scholars have thus argued that burdensome firm entry regulation

UNU-MERIT Working Papers intend to disseminate preliminary results of research

Simplifying entry regulation has been a popular reform since the publication of Djankov and others (2002). The inclusion of business entry indicators in the World Bank’s Doing Business project has led to an acceleration in reform: in 2003–08, 193 reforms took place in 116 countries. A large academic literature has followed: 201 academic articles have used the data compiled by Djankov and others (2002) and subsequently by the World Bank. The author identifies three theories as to why some countries impose burdensome entry requirements. He also surveys the literature on the effects of making

We compare the economic consequences and political feasibility of reforms aimed at reducing barriers to entry (deregulation) and improving contractual enforcement (legal reform). Deregulation fosters entry, thereby increasing the number of firms (entrepreneurship) and the average quality of management (meritocracy). Legal reform also reduces financial constraints on entry, but in addition it facilitates transfers of control of incumbent firms, from untalented to talented managers. Since when incumbent firms are better run entry by new firms is less profitable, in general equilibrium legal reform may improve meritocracy at the expense of entrepreneurship. As a result, legal reform encounters less political opposition than deregulation, as it preserves incumbents ’ rents, while at the same time allowing the less efficient among them to transfer control and capture (part of) the resulting efficiency gains. Using this insight, we show that there may be dynamic complementarities in the reform path, whereby reformers can skillfully use legal reform in the short run to create a constituency supporting future deregulations. Generally speaking, our model suggests that “Coasian ” reforms improving the scope of private contracting are likely to mobilize greater political support because — rather than undermining the rents of incumbents — they allow for an endogenous compensation of losers. Some preliminary empirical evidence supports the view that the market for control of

Entry requires external finance, especially for less wealthy entrepreneurs. In countries with weak constrains on politicians, incumbents may lobby for poor enforcement of investor protection in order to limit competition. In a broad cross-section of countries and industries, we find that countries with more accountable political institutions, defined as having better private monitoring of political choices, have better investor protection and lower entry costs. Moreover, entry rates and the number of producers are positively correlated with effective investor protection and entry costs in more nancially dependent sectors. We conclude that access to finance is critical to entry, and that private monitoring of political choices increases the political cost of undermining access. In general, both political and legal factors affect access to finance.