the role of finance and microentrepreneurship in the informal economy.compressed
TRANSCRIPT
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The Role of Finance and Microentrepreneurship in the Informal Economy Pontus Engström School of Business and Law - University of Agder 20 June 2016
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Muhammad Yunus
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Criticism to Microfinance
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• Duvendack et al (2011) – “Our report shows that almost all impact evaluations of microfinance suffer from weak methodologies and inadequate data, thus the reliability of impact estimates are adversely affected”
• Armendáriz de Agion and Morduch (2005, 2010) – It is widely acknowledged that no well-known study robustly shows any strong impact of microfinance.
• Roodman & Mordouch (2013) – “We show that the original results on poverty reduction disappear after dropping outliers, or when using a robust linear estimator.”
• Bateman (2012) – “There is very little if not no impact from microfinance”
Thus, why is it that financing of microenterprises in the informal economy is not yielding a positive impact?
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Milford Bateman – “there is very little if not no impact from microfinance”
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Schumpeter (1934) The Theory of Economic Development
• A dynamic framework where demand and supply interact in a circular flow, striving to equilibrium
• At the center is the entrepreneur who seeks for changes to reach an improved economic state.
• Through innovation, the entrepreneur mixes the available resources into new combinations.
• “entrepreneurs are a special type”
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Positioning financing of microentrepreneurs in the stream of entrepreneurship literature
Context: Intersection of enterprising individuals, a microfinance institution and the informal economy
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Three empirical essays
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Figure 5. Schematics of essay and theory.
Essay 1: How does Resource
Abundance Enhance
Microenterprise Performance in
the Informal Economy?
Existence of Entrepreneuria l Opportunities
Discovery of Entrepreneuria l Opportunities
Decision to Exploit Entrepreneuria l Opportunities
Essay 2: The Impact of
Entrepreneur Characteristics on
Financing in the Informal Economy
Essay 3: Financial l iteracy, Role
Models and Micro-Enterprise
Performance in the Informal
economy
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Research context: The informal economy?
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Informal businesses are businesses which operate out of sight of government
regulation, either completely or in some small capacity
(Diana Enriquez, 2014, informal economy investigator TED fellow)
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Why the informal economy?
• The majority of economic activity in many developing countries takes place in such ‘shadow’ microenterprises (Bruton et al. 2008; Webb et al. 2009; Williams and Nadin 2012).
• For many developing countries, such as Ecuador, Tanzania and India, employment in the informal economy affects more than 80% of the population (ILO 2013).
• These microenterprises are commonly overlooked because they operate mostly out of view of government regulations, government statistics and interaction with established institutions.
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Faces of informality
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Faces of informality
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Faces of informality
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High Risk of Robbery
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Research design - 755 micro entrepreneurs in the
coastal areas of Ecuador
- Widespread informality (80%)
- Obtained from a sample of clients of a MFI in Ecuador, servicing 42.000 clients
- Data from national statistics and credit bureau
- Complementary telephone survey
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How does Resource Abundance Enhance Microenterprise Performance in the Informal Economy?
Essay 1
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Theories Resource Based View • Firm resources include all assets, capabilities, organizational processes, firm attributes, information, knowledge (Barney, 1991)
• Provides a sustainable competitive advantage if valuable, rare and not imitable
• Human Capital theory 19
Prospect Theory • Kahneman & Tversky (1979) suggesting that individuals tend to exaggerate the fear of failure in comparison to a sure gain. In the informal economy, we may therefore see a high variability in performance level.
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Measure of Firm Performance
Challenge: unaudited numbers Profits (net income)
• Microentrepreneurs in these small businesses do not pay themselves a salary, hence we have adjusted the numbers such that an opportunity cost for labor is deducted from the net income.
Return on Assets (ROA) (Net income / total assets) • The challenge with this measure is that if the asset number is very small, then the
ROA will become very large. To minimize this impact, the asset number is Windsorized at the 10% level
Sales growth (Avg sales in t+1 and t+2 compared to t-1 and t-2) • Given that all credit assessments are not done every year, we use a binary dummy
variable where we compare average sales in 2014 and 2015 with average sales during the period 2009-2013, whereby firms growth is coded as 1 if firms grow their sales and as 0 if there is no improvement or a decrease in sales levels.
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Observations without debt (n=969)
Observations with debt (n=1,202)
Full panel sample (n=2,171)
Mean Min Max Mean Min Max Mean Std.
Deviation Net sales (USD) 19,101 0 216,000 30,369 1,800 360,000 25,340 27,529
Net income (USD) 3,475 -5,736 71,808 7,197 -1,968 101,940 5,536 7,138 Unadjusted ROA (%) 186% -21% 7200% 104% 13% 1103% 141% 318% Adjusted ROA (%) 78% -1371% 5280% 60% -175% 618% 68% 199% Winsorized ROA (%) 61% -174% 2611% 61% -163% 618% 61% 93% Asset turnover 5.7 .2 182.6 3.2 .3 41.3 4.3 7.8
Profit margin (%) 16% -114% 97% 22% -109% 81% 19% 16% Debt/assets (%) 0% 0% 0% 20% 0% 97% 11% 17% Debt/equity (%) 0% 0% 0% 43% 0% 3297% 24% 97% Total assets (USD) 9,092 68 61,700 15,848 330 269,800 12,833 14,289 Employees (#) 1.6 0 15.0 1.7 0 15.0 1.7 1.8
Urban (%) 90% 17% 100% 86% 20% 100% 88% 17%
Education level 1.6 0 3.0 1.6 0 3.0 1.6 .6 Age 42.5 19.0 67.0 43.3 22.0 66.0 43.0 10.7
Note: Adjusted and unadjusted ROE and ROA refer to adjustment for the opportunity cost of labour. The data relate to observations of 755 randomly selected firms during the time period 2005-2013.
If interest rates are 26%, the returns are roughly twice
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Hypothesis 1 – a positive relation between those who make use of microcredit and firm performance
Based on the riskiness of the microenterprise’s investment opportunities (risk of business failure), it would be rational for a microentrepreneur to demand (a priori) a high financial return if they chose to expand their business activities by using (more) debt. Findings: Supported in a recent cross sectional analysis (2013) for both ROA and Sales growth (but not profits). Implication: Those who take on debt earn a higher return than those who do not, possibly to safeguard against risk of failure.
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Hypothesis 2 – there is a positive association between leverage and firm performance
Lacking capital limits the available opportunity set (Evans and Jovanovic 1989), thus hindering experimentation with cash as a resource cushion (Cyert and March 1963; Bourgeois 1981).
Findings: Supported in a recent cross sectional analysis (2013) for both ROA and Profits (but not Sales Growth). Panel shows only support for Profits Implication: Relative the rest of the economy, informal business remain small, but do earn higher profits.
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Hypothesis 3 – there is a positive and curvilinear (concave) association between human capital investments and firm performance
Mincer Human Capital Equation (Mincer 1974) log Yi = β0 + β1Ei+ β2Xi + E
where Y = income, E = years of schooling, and X years of experience Findings: Education is not benefiting
Performance, and with experience the relationship is negative, and accelerating. Implication: In the informal economy, human capital as a resource is not captured through education, nor is it accumulated over time. More policy focus on relevant education, skills and building human capital.
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Experience
Perf
orm
ance
Experience
Perf
orm
ance
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Hypothesis 4 – there is a negative and curvilinear (concave) association between firm size and firm performance
• Informal economy is isolated • Engaged in similar activities
• Adding capacity ≠improved economies of scale • Adam Smith argued for positive economies of scale • Diminishing economies of scale in this context.
Findings: Supported for ROA and Profits but no impact on Sales Growth. Implication: Adding capacity to smaller enterprises it no necessarily adding income or enhancing profitability. Larger firms may benefit more.
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Size
Perf
orm
ance
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The Impact of Entrepreneur Characteristics on the Financing of Micro-Firms in the Informal Economy
Essay 2
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Theories Pecking-order theory • Capital structure emerges as a result of the various financing options available to a firm (Myers and Majluf, 1984)
Tradeoff theory • The firm weighs the costs and benefits of alternative forms of financing (Titman and Wessels, 1988), “holding the firm’s assets and investment plans constant” (Myers 1984: 577).
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Theories Human capital theory • Individuals have a certain skill set and psychological aptitude (Becker, 1994)
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Findings
Financial decision Entrepreneur characteristics
§ Age2
§ Financially literate § Not married
Firm characteristics
§ Size § Asset structure § Growth intent § ROA and ROA2
Amount of debt Entrepreneur characteristics
• Financially literate
Firm characteristics • Size • Less fixed assets
• ROA Other characteristics
• Rural
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Implications
• Micro-entrepreneurs who are more financially literate are more prone to select external debt financing
• Size affects the entrepreneur’s decision to take on debt, but, compared with previous findings on formal firms, our findings attribute more weight to firm size in the financing decision.
• Asset structure shows a negative relationship with leverage, possibly because of the greater need for working capital, as market is illiquid generally.
• Growth intent is related to the decision to finance • High variability in returns require a high safety margin • Rural entrepreneurs take on more debt, possibly a selection bias by the credit
officer.
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Financial Literacy, Role Models and Micro-Enterprise Performance in the Informal Economy
Essay 3
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Theories Resource Based View • Firm resources include all assets, capabilities, organizational processes, firm attributes, information, knowledge (Barney, 1991)
• Provides a sustainable competitive advantage if valuable, rare and not imitable
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Financial literacy: Lusardi & Mitchell (2014) Role models: Aldrich (1999), Minniti (2005)
Previous Research
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Previous literature on Financial Literacy
Lusardi & Mitchel (2014), The economic importance of financial literacy: Theory and evidence Journal of Economic Literature
Atkinson & Messy (2012). Measuring Financial Literacy: Results of the OECD. Bucher-Koene & Lusardi (2011). Financial literacy and retirement planning in Germany Crossan, Feslier & Hurnard (2011). Financial literacy and retirement planning in New
Zealand. JPEF
Sekita (2011). Financial literacy and retirement planning in Japan. JPEF Fornero & Monticone (2011). Financial literacy and pension plan participation in Italy.
JPEF Lusardi (2012), Numeracy, financial literacy, and financial decision-making. NBER Beckmann (2013). Financial literacy and household savings in Romania. Numeracy.
Drexler, Fischer & Schoar (2014). Keeping it simple: Financial literacy and rules of thumb. AEJ: Applied Economics.
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Contribution: This study extends the measurement of financial literacy to the informal economy, and relates it to the impact on micro-enterprise
performance
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Hypothesis 1
Among microenterprises in the informal economy, there is a positive association between an entrepreneur´s financial literacy and microenterprise financial performance.
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Financial literacy
Financial performance
+
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Previous literature on Role Models
Aldrich (1999) – individuals take decision on social cues Minniti (2005) – role models help reduce the ambiguity in decision making
Honig (1998) – an external network is beneficial to performance Bosma et al (2012) – impact of role models on entrepreneurial intentions
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Contribution: This study extends the measurement of role models and relates it to the impact on micro-enterprise performance
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Hypothesis 2
Among microenterprises in the informal economy, there is a positive association between the usage of role models and microenterprise financial performance.
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Role models Financial performance
+
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Questions asked on Financial Literacy (modifying one question to fit this context) – Nr of correct answers.
1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102?
2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
3. Do you think that the following statement is true or false? Investing everything in one opportunity usually provides a more certain economic reward than investing smaller amounts in many different opportunities.
Original question (from Lusardi): Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
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Measuring exposure to successful role models
On a scale from 1 through 5, interviewees were asked to indicate their level of agreement with the following four statements:
1. I am personally familiar with successful entrepreneurs. 2. In my network of friends and colleagues, there are successful
entrepreneurs. 3. I regard some of the entrepreneurs I know as role models. 4. Some entrepreneurs I know have been a source of influence for me.
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Note: We offered respondents the response scale of strongly disagree, disagree, neither disagree or agree, somewhat agree and fully agree, rather than the numerical statements of a 5-point scale.
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Controls
• Age • Age2
• Level of education • Gender • Leverage (debt/equity) • Size ln • Urban location • Industry
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Comparing the results from the informal Ecuador with other formal Economies
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Financial literacy is significant in relation to ROA and Profits but not Sales growth. Roles models is significant in relation to ROA, but not Profits or Sales growth
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Model 1 Model 2 Model 3
ROA Profit Sales growth
(Logit) H1: Financial literacy .090 ** .082 ** -.011
(2.617 ) (2.834 ) (0.180 )
H2: Role models .091 ** .048
-.273
(2.614 ) (1.681 ) (0.281 )
Controls Loan experience .132 *** .173 *** .182 *
(3.678 ) (5.717 ) (0.074 )
Age -.066
-.138 *** -.011
-(1.805 ) -(4.488 ) (0.019 )
Age2 -.032
-.031
.000
-(0.916 ) -(1.085 ) (0.002 )
Level of education -.018
-.034
-.123
-(0.520 ) -(1.114 ) (0.291 )
Gender (male = 1) .064
.064 * -.271
(1.768 ) (2.105 ) (0.398 )
Leverage (debt / equity) .159 *** .125 *** .161
(4.694 ) (4.407 ) (0.769 )
Size ln -.336 *** .558 *** -1.322 ***
-(9.061 ) (17.914 ) (0.321 )
Nr of employees .066
.083 ** .114
(1.890 ) (2.834 ) (0.106 ) Urban location (%) -.105 ** -.100 ** 1.325 -(3.055 ) -(3.480 ) (1.069 ) n 755 755 219 Adjusted R2 .174
.418
Cox and Snell R2 .167 Nagelkerke R2 .246 Displayed beta is standardized. t-value within parenthesis. Profits are winsorized at 5% level. Industry controls are included but not reported. ΔR2 is over and above control variables.
∗ Significant at the 5% level; ∗∗ significant at the 1% level; ∗∗∗ significant at the .1% level.
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Summary of key findings
• Microcredit supports ROA and Profits in a cross sectional analysis, but is only seen to support increased profits in a panel study. Sales growth is not affected.
Ø Despite growth intent, growth is difficult. Microcredits puts money on the table. • There is a negative and curvilinear (concave) association
between firm size and firm performance (ROA and Profits). Ø Bigger is not always better • Entrepreneur characteristics affect financing decisions and those who apply for debt have a growth intention. Size is important.
Ø Being financially literate impacts the financing decision and Size matters. • Financial literacy, found to be very poor, is significant in relation to ROA and
Profits but not Sales growth. Other skills may be needed, such as marketing. Ø Being financially literate leads to improved decision making • Roles models is significant in relation to ROA, but not Profits or Sales growth.
Indicator of making better investment decisions. Ø Knowing another successful entrepreneur helps generate higher ROA
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Size
Perf
orm
ance
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Takeaways for practitioners
• Despite criticism, Microcredit does put a little extra money on the table
• Growth is difficult and may even come at a cost (lower ROAs and lower Profits). Bigger is not necessarily better.
• Financial literacy is in general uncomfortably low, and questions the morality in extending loans with high interest rates to large un-educated population groups
• Large social reforms, are needed as education nor experience is adding enough skills and competence to make a difference in these micro-firms. With an average of 5 years schooling, micro-entrepreneurs in the informal economy are essentially wing-clipped.
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In addition to social reforms – are there other measures which can be taken?
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