How Do Banks Screen Innovative Firms? Evidence from Start-Up Panel Data

In this working paper we analyse bank screening with regard to the use of hard and soft information. We are interested in differences in the effect of an external credit rating on the use of bank finance, the share of bank to total finance and bank difficulties between newly founded firms in High-Tech vs. Low-Tech industries. We analyse the effect of different rating classes, as well as the availability of a rating. Further we examine whether the effect of bank characteristics differ between High-Tech and Low-Tech firms. In particular, we look at the effects of bank size as a proxy for the bank’s hierarchal structure and the bank’s expertise and specialization in the firms industry. We employ the KfW/ZEW start-up panel dataset covering 9,715 firms established in the years 2005-2009. The panel tracks firms over the period 2007-2009 and we can make use of up to three consecutive firm observations. Each firm is assigned with its credit rating provided by Creditreform. Each firm is linked with the characteristics of its main bank. Our results also suggest that banks rely less on external rating information in their decision making for High-Tech firms. The availability of a credit rating hampers access to bank finance only when the rating is bad. Firms without rating or with a fair or good rating have similar access to bank finance suggesting that banks only employ negative signals from credit ratings in their decision making. We find an interesting difference between High-Tech and Low-Tech firms as our results seem to indicate that a bad rating is less harmful in terms of bank finance for firms in the High-Tech sector than in the Low-Tech sector. The size of a firm’s main bank also determines whether start-ups face difficulties in obtaining bank finance. Our results suggest that firms that have their main relation with a larger bank use less bank finance and report more difficulties in getting credit. By contrast, a larger expertise of the bank in the firm’s industry is not associated with fewer difficulties to get bank loans. Bank expertise affects the bank share but there is no evidence on difficulties.

Brown, Martin, Hans Degryse, Daniel Höwer and Maria Fabiana Penas (2012), How Do Banks Screen Innovative Firms? Evidence from Start-Up Panel Data, ZEW Discussion Paper No. 12-032, Mannheim.