Housing Collateral, Credit Constraints, and Entrepreneurship-Evidence from a Mortgage Reform

by Thais Laerkholm Jensen, Søren Leth-Petersen & Ramana Nanda

Overview — One of the strongest findings in studies of entrepreneurship is the clear positive correlation between personal wealth and the propensity to engage in entrepreneurship. One study, for example, has shown that entrepreneurs comprise just under 9 percent of households in the United States, but hold about 40 percent of total net worth. The most common explanation for this correlation is that credit constraints pose an important barrier to entry for less wealthy individuals. However, others have questioned the degree to which financing constraints are barriers to entrepreneurship, particularly in advanced economies where firms have adequate access to capital. In this paper, the authors consider a unique mortgage reform in Denmark to study how increasing access to credit through the unlocking of housing collateral for personal loans had an impact on entrepreneurship. Findings show that the reform affected the ability to draw on debt backed by home equity. However, despite the positive and statistically significant effect of relaxing credit constraints on entrepreneurship, the magnitudes are small. Furthermore, an important reason for the small magnitude was that the marginal business founded by those who benefited from the reform was of lower quality, where the new entrants failed within two years of entry. Overall, the results paint a more nuanced picture of the extent to which financing constraints are important in settings with well-developed credit markets, and the role that home equity can play in alleviating these. Key concepts include:

  • Findings address the longstanding question of the importance of credit constraints for entrepreneurship.
  • Housing collateral shifts the bank's adjudication decision from a specific project to the creditworthiness of the borrower. On the one hand, good entrepreneurial projects may be able to be started or sustained. On the other hand, though, optimistic entrepreneurs may start lower quality businesses because they do not face the same discipline from the bank.

Author Abstract

We study how a mortgage reform that exogenously increased access to credit had an impact on entrepreneurship, using individual-level micro data from Denmark. The reform allows us to disentangle the role of credit access from wealth effects that typically confound analyses of the collateral channel. We find that a $30,000 increase in credit availability led to a 12 basis point increase in entrepreneurship, equivalent to a 4% increase in the number of entrepreneurs. New entrants were more likely to start businesses in sectors where they had no prior experience and were more likely to fail than those who did not benefit from the reform. Our results provide evidence that credit constraints do affect entrepreneurship but that the overall magnitudes are small. Moreover, the marginal individuals selecting into entrepreneurship when constraints are relaxed may well be starting businesses that are of lower quality than the average existing businesses, leading to an increase in churning entry that does not translate into a sustained increase in the overall level of entrepreneurship.

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