Financial Frictions, Cyclical Fluctuations, and the Growth Potential of New Firms

Abstract

We develop a model in which entrepreneurs choose between startup types with heterogeneous short- and long-run growth potential, and we generate testable predictions on the differential effects of financial factors and cyclical fluctuations on these startups. Using a multi-country entrepreneurship survey, we find that, consistent with the model, higher borrowing costs during financial crises negatively affect high-growth startups considerably more than low-growth startups, especially during severe downturns. Our results, supported by additional tests using sector-level financial frictions indicators, uncover a new channel that is potentially important to explain slow recoveries after financial crises.