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Small business survival and inheritance: evidence from Germany


This paper investigates whether small businesses face financial constraints that affect their survival. A model of moral hazard is developed in which financial constraints arise endogenously. The model predicts that higher private assets relax financial constraints and have a positive effect on the firm’s probability of survival. The empirical analysis confirms that the entrepreneur has a higher propensity to stay in business when she inherits capital. This effect is particularly strong for entrepreneurs who switch from self-employment into wage employment.

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  1. Kaplan and Zingales (1997) argue about measurement of financial constraints.

  2. Aghion et al. (1999) stress the importance of entrepreneurial firms for innovation. Moreover, small scale enterprises are said to be crucial for channeling financial sector reforms into growth (King and Levine 1993).

  3. See also Cressy and Olofsson (1997) and references therein for comprehensive analysis of small business financing in Europe.

  4. Citation: The Economist, “The loan factory”, April 16th, 2005.

  5. Testing for the importance of financial constraints by using the stock variable wealth is subject to an endogeneity problem. See e.g., Xu (1998) and Hurst and Lusardi (2004).

  6. Hurst and Lusardi (2004) argue that inheritance cannot be considered as an exogenous increase in wealth. They suggest that the time of the windfall relative to the business entry decision is crucial, and that individuals who receive an inheritance are also more likely to start a business before receiving an inheritance. We also experiment with current and lead values of inheritance and get marginally significant and insignificant relationships, respectively.

  7. Certain cash flows are never achieved: p j (I *, θ) < 1.

  8. Note that pledging of assets implies a dead-weight loss as liquidation through the bank leads to transaction costs. Using personal funds would enhance survival rates and result in cheaper financing for firms. However, the liquidation of inherited assets may be more expensive on the individual level. For example, the liquidation of an inherited family house may cause huge amounts of non-monetary costs for a business owner that can be avoided by taking a credit and pledging the house as collateral.

  9. Note that additional pledgable assets increase the attractiveness of the non-screening option as the expected profit \(\bar{E}_h(IR_h, A)\), generating indifference between the two project qualities, E h (I R h , A) = E l (IR h , A), increases. A jump in available assets may thus increase \(\bar{E}_h(I R_h, A)\) to such a level that the screening option is ruled out and banks invest a lower amount of I, I < I * S , due to their credit constraint C = I *I(A). However, a negative jump in the probability of success will never occur if banks are not efficient enough in screening.

  10. The positive, independent influence of an increase in X on the probability of survival can be derived from the equation that defines indifference between h and l: p h XIp l Yp l /p h I. If the gross return of the h variant becomes X + Δ the left hand side increases. An increase in I restores equality, and implies that with a higher X the incentive compatibility constraint (1) allows a higher investment.

  11. A second concern is that inheritance allows individuals to stay in business too long as the additional private funds may enable self-employed individuals to cover business expenditures despite loss-generating operations, or to cover unforeseen expenses which would otherwise threaten the firm’s survival. However, given that individuals act rationally and are profit maximizing, they will employ their inheritance for improving the survival chances only if the expected net value of such a strategy is positive. If this is the case and capital markets are perfect, that is, no asymmetric information and moral hazard is present, banks should be also prepared to finance this period of distress. Thus inheritance should have no impact. If the motive of profit maximization is prevailing, the fact that inheritance is needed to overcome the distress situation indicates existence of capital markets imperfections such as asymmetric information and moral hazard.

  12. For a more detailed description of the GSOEP see Lechner (1999) or Constant and Zimmermann (2006). Alternatively, visit for comprehensive data information.

  13. For example, serial entrepreneurs are often said to be extraordinarily risk loving.

  14. The models are estimated using Stata 9.2 software package. The do-files with codes are available upon request.

  15. Results are available upon request. The assumptions about a particular parametric distributions are hard to justify. Hence, we also check the robustness of results using Gaussian distribution for the unobserved heterogeneity term. The results follow the pattern of the reported estimates. Furthermore, we cannot reject the hypothesis of zero unobserved heterogeneity.

  16. See


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Standard disclaimer applies. Many thanks for helpful comments to the anonymous referees and the Editor as well as to participants at the 2006 European meeting of the Econometric Society in Vienna, and 2006 meeting of the German Economic Association in Bayreuth. Financial assistance by the German Science Foundation (DFG, SCHA841/1-2) is gratefully acknowledged.

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Correspondence to Dorothea Schäfer.



Proof of Proposition 1

For A = 0 both project qualities yield equal profit if

$$ p_h X- I = p_l Y- \frac{p_l}{p_h} I. $$

This equality is only satisfied with I = 0 for the benchmark type \(\hat{\theta}\). If quality h were realized and 〈R h I〉 were offered the benchmark type \(\hat{\theta}\) would face perfect financial constraints. Now, consider projects for which Assumption 1 is satisfied. Given that \(\theta_i > \hat{\theta}\) and I = 0 the left hand side of (4) increases. Note that an increase in I decreases the left hand side more than the right hand side. Thus, for \(\theta_i > \hat{\theta}\), equality in (4) can be restored with some \( I=\hat{I} > 0 \). Since ∂E h i , ·)/∂θ i  > 0, the crucial amount of I that satisfies (4) increases if θ i increases: \(\partial\hat{I}/\partial \theta_i > 0\). The monotonicity of the relationship between \(\hat{I}\) and θ i implies that there exists a \(\theta_i=\tilde{\theta}\) for which the loan granted in equilibrium approaches I *, and financial constraints vanish. The second step of the proof takes into account the possibility that the bank could alternatively offer only contract 〈R l I * l 〉. Note that the optimal I in case of 〈R l I * l 〉, which satisfies

$$ \frac{\partial E_l}{\partial I}= \frac{\partial p_l(I,\bar{\theta})}{\partial I} Y-1=0 $$

is smaller than the optimal I in case of 〈R h I *〉, which satisfies

$$ \frac{\partial E_h}{\partial I}= \frac{\partial p_h(I, \theta_i)}{\partial I}X-1=0. $$

Thus, financial constraint C = I *I * l arises if banks, in order to avoid losses, offer only 〈R l I * l 〉. Recall that \(E_h(\hat{I})\) increases monotonically if quality h becomes better. Moreover, \(E_l(I_l^\ast, \bar{\theta}) > E_h(\hat{I},\hat{\theta})\) in the benchmark case. Both properties imply that there exists a crucial level \(\theta_i=\breve{\theta}\) such that \(E_l(I_l^\ast, \bar{\theta} )=E_h(\hat{I}, \theta_i)\). For a rather small difference between l and h, that is, ability is in the range of \(\theta_i\in ( \hat{\theta}, \breve{\theta})\), the active financial constraint is C = I *I * l since the bank only offers 〈R l I * l 〉. For all \(\theta_i\in (\breve{\theta}, \tilde{\theta})\) the active financial constraint is \(C=I^\ast-\hat{I}\).   q.e.d.

Proof of Proposition 2

The profit for all \(\theta_i > \hat{\theta}\) is given by

$$ E_h = p_h X - I - (1-p_h)(1-\beta)A $$


$$ E_l = p_l Y - \frac{p_l}{p_h} I - (1-p_l) \left({1 -\frac{1-p_h}{1-p_l} \frac{p_l}{p_h}\beta}\right)A $$

for quality h and l, respectively. Consider a given type θ with \(\theta_i\in (\hat{\theta}, \tilde{\theta})\). For symplicity we assume β = 1. Recall that without private assets the firm is constrained by (4). If pledgable assets are available, the profit function for quality l is lowered but the profit function for quality h remains unchanged. This feature, in combination with (4), immediately implies

$$ p_h X - I - (1-p_h)(1-\beta)A=p_l Y - \frac{p_l}{p_h} I - (1-p_l) \bigg(1 -\frac{1-p_h}{1-p_l} \frac{p_l}{p_h}\beta\bigg)A $$

only for \(I=\hat{I}(A > 0) > \hat{I}(A=0).\) The lowering of E l induces \(E_h(\hat{I}(A > 0), A) > E_h(\hat{I}, A=0)\) for all \(\hat{I}(A > 0)\in(\hat{I}(A=0),I^\ast)\). With β < 1, both profit functions are lowered if debt is secured. However, because of (1−p h )p l /(1−p l )p h  < 1, the decrease for profit E l is always larger than the decrease for E h . This feature, in combination with the fact that \(E_h(\hat{I}(A > 0), A)\) increases with \(\hat{I}(A > 0)\) for β = 1, guarantees that \(E_h(\hat{I}(A > 0), A)\) also increases for β = 1−δ, where δ is not too large. Thus, the pledging of assets is compatible with C2. It increases profits as it allows a greater I. However, for types \(\theta_i \in (\hat{\theta}, \breve{\theta})\), the increase in profits has to be large enough to exceed E l (R l I * l ) if assets were to ease financial constraints.   q.e.d.

Proof of Proposition 3

Consider S = 0. In this case E S h (I *, S = 0) > E h  = E l since investment incentives are not distorted in case of the screening option, and the pledging of assets and the reduced investment in the non screening case lowers profit E h as the entrepreneur has to bear the dead-weight cost. Differentiation of E S h yields

$$ \frac{\partial E_h^S}{\partial I}= \frac{\partial p_h}{\partial I} X-1\quad \rightarrow \quad \frac{\partial p_h(I^\ast_S)}{\partial I}=\frac{1}{X} $$
$$ \frac{\partial E_h^S}{\partial S}= -1 < 0. $$

The first derivative (6) indicates that the optimal investment level I * is independent of S. The second derivative (7) shows that the maximal profit decreases monotonically with S. For a given type, the amount of pledged assets A determines investment and profit in the non-screening scenario. Both properties and E S h (I *, S = 0) > E h  = E l ensure that, for each given amount of pledged assets, there exists a level \(\bar{S}\) such that C5 is satisfied for all \(S < \bar{S}\). In this array of S, the available amount of assets will not be pledged. Thus, assets have no influence on the firms’ success probability. If \(S > \bar{S}\), C5 is not satisfied. Assets secure the debt and Proposition 2 applies.    q.e.d.

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Schäfer, D., Talavera, O. Small business survival and inheritance: evidence from Germany. Small Bus Econ 32, 95–109 (2009).

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  • Entrepreneurship
  • Survival
  • Financial constraints

JEL Classifications

  • G30
  • J20
  • L10
  • L26