A presentation held by professor Per Strömberg, Swedish House of Finanice, at the high level seminar "Towards a sustainable financial system" hosted by the Stockholm based think tank Global Challenge in cooperation with London School of Economics and The Swedish House of Finance on September 12th 2013.

1. 1
Per
Strömberg
2013-­‐09-­‐12
Sustainable
financial
system:
Is
there
an
”
equity
gap”?

2. 2
BANK
LENDING
DURING
THE
CRISIS
23
Tables and Figures
Figure 1 Syndicated loan market: Total global issuance
Notes: The chart depicts total syndicated lending during 1992–2010. The blue line is based on almost 40,000 syndicated loans extended between Jan 2005 and
Dec 2010, from Loan Analytics. The red line, for comparison, shows data from the BIS Quarterly Review March 2012, Table 10 representing “Signed
international syndicated credit facilities (with maturity less than 3 months)” and available on http://www.bis.org/statistics/secstats.htm. The difference between
the two lines reflects the exclusion by the BIS of loans with maturity greater than 3 months. Data sources: Loan Analytics, BIS.
0
10
20
30
40
50
60
70
80
90
100
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
USdbillion
Share of total volume to advanced economies (right-axis), %
New syndicated loans to all countries (Loan Analytics)
New syndicated loans to all countries (BIS)

3. 3
• In
the
crisis,
saw
a
simultaneous
reducRon
in
lending
and
investment
• But
is
it
supply-­‐
or
demand-­‐driven?
• SubstanRal
evidence
that
weak
bank
balance
sheets
caused
a
decrease
in
lending
to
firms
during
the
crisis
- Ivashina
&
Scharfstein
(2010),
CorneY
et
al
(2011),
Jimenez
et
al
(2012),
Kapan
&
Minoiu
(2013)
REAL
EFFECTS
OF
FINANCIAL
CRISES:
METHODOLOGICAL
PROBLEMS

4. 4
• Even
if
crisis
caused
weak
banks
to
lend
less,
not
clear
what
net
effects
on
firms
are
- Did
stronger
banks
”pick
up
the
slack”?
• Some
evidence
on
real
economic
effects
of
reducRon
in
lending
on
large
public
firms
- Almeida
et
al
(2013),
Becker
and
Ivashina
(2013)
• Suggest
that
effects
on
investment
of
large
public
corporaRons
was
relaRvely
small
- Access
to
bond
and
equity
markets
o Public
markets
recovered
much
quicker
than
banks
- Strong
bank
relaRonships
REAL
EFFECTS
OF
THE
FINANCIAL
CRISIS

5. 5
• Small,
private
firms,
where
bank
financing
is
only
alternaRve
- Caveat:
not
much
solid
crisis
evidence,
due
to
lack
of
data
- Previous
evidence
on
bank
lending
channel
suggests
that
small
firms
more
affected
(e.g.
Kashyap
et
al,
1994)
• Even
for
newly
started,
entrepreneurial
firms,
bank
debt
much
more
important
than
equity
- Robb
and
Robinson
(2012)
o Debt
51%
o Entrepreneur’s
own
equity
31%
o Outside
equity
17%
§ VC
5%
THE
REAL
VICTIMS:
SMALL
FIRMS
(?)

6. 6
EXAMPLE:
LENDING
TO
UK
SMALL
BUSINESSES
The impact of the financial crisis on SME lending
Since 2008 banks have reduced their lending to small & medium-
sized firms (SMEs)
6
-10
-5
0
5
10
15
Year
E urozone UK US
+++
Average
2002-2007
2008 2009 2010
Bank Lending Capacity Growth (%)
A Guide to the European Loan Market, March 2011.
Bank Lending to UK Small Business (%)

7. 7
• Bank
lending
have
not
fully
recovered
- Need
for
recapitalizaRon
- Effects
of
Basel
III
on
SME
lending?
• Small
firms
cannot
access
tradiRonal
bond
markets
• Will
”shadow
banking”
system
take
care
of
it?
- Factoring,
leasing,
trade
credit
–
important,
but
only
suitable
for
some
types
of
investment
o And
dependent
on
bank
credit
supply
as
well
• Micro-­‐bonds?
- Listed
or
unlisted
issues
of
<
€50
M;
”light-­‐touch”
regulaRon
- Investors
are
individuals,
typically
located
in
vicinity
of
firms
WILL
ALTERNATIVES
TO
BANK
DEBT
EMERGE?

8. 8
EXAMPLE:
GERMAN
MICRO-­‐BOND
ISSUES
German issuers
10
≈150 German issuers have raised ≈ €8 billion with ≈ 200 listed and
unlisted bond issues
From: Wardrop, “From bank financing to bond financing: financial
exchanges and the SME micro bond market” (2013)

9. 9
• Is
there
an
”equity
gap”
for
companies
• In
the
aggregate,
external
equity
is
of
relaRvely
minor
importance
for
firms
relaRve
to
retained
earnings
and
debt
- External
equity
is
costly
- Asymmetric
informaRon
and
moral
hazard
problems
WHAT
ABOUT
EQUITY
FINANCING?

10. 10
AGGREGATE
SOURCES
OF
FUNDING
FOR
CAPITAL
EXPENDITURES,
U.S.
CORPORATIONS
Source: Federal Reserve Flow of Funds; Berk & DeMarzo.

11. 11
• External
financing
is
parRcular
problem
for
early
stage
firms:
- Low
profits
à
debt
capacity
limited
- Extreme
adverse
selecRon
and
moral
hazard
problems
• ExternaliRes
of
entrepreneurship
and
innovaRon
- Benefits
from
entrepreneurial
firms
to
the
economy
are
larger
than
the
monetary
returns
to
investors
- E.g.
R&D,
spillovers
• Case
for
government
intervenRon
in
entrepreneurial
finance
- High
on
the
policy
agenda,
e.g.
Government
sponsored
VC
funds
• As
seen
earlier,
however,
most
important
equity
is
inside
equity
- Personal
savings
and
retained
earnings
- ”Agency-­‐free”
funding
• Clear
policy
implicaRon:
improve
supply
of
inside
equity
- Corporate
and
personal
taxes
EQUITY
FINANCING
FOR
SMALL
FIRMS

12. 12
• Venture
capital
- Professional
funds
raising
insRtuRonal
capital
to
invest
in
early-­‐stage
firms
- 10-­‐year
funds
à
limited
holding
period
à
invest
in
extremely
fast-­‐
growing
”gazelle
firms”
- 30%+
return
requirements
for
investments
• Hence,
only
suitable
for
small
subset
of
growth
ventures
- SRll
very
important
for
economy:
most
”new”
important
firms
iniRally
VC
financed
- Apple,
Microsos,
Google,
Facebook,
Genentech,
Amazon,
SpoRfy,
etc.
• Common
view
that
entrepreneurship
in
Europe
suffering
from
lack
of
VC
- Some
truth
to
this,
but
problem
even
in
the
US.
- Not
a
result
of
the
crisis,
but
more
structural
PRIVATE
EQUITY
I:
VENTURE
CAPITAL

13. 13
VC FUNDRAISING (U.S.) AS % OF MARKET CAP

14. 14
• Problem
with
(not
only)
European
VC
- Suffering
from
mediocre
returns
post-­‐2000,
especially
in
Europe
- Lack
of
scalability
in
VC
o Problem
for
fund
managers
o Problem
for
insRtuRonal
investors
- Limited
investment
horizon
à
have
to
be
able
to
exit
within
5-­‐6
years
- à
Less
interest
in
VC,
funds
moving
to
later-­‐stage
investments,
less
capital
intensive
investments
• Leads
to
a
”financing
gap”
for
early
stage
financing.
• Some
government
policies
work
beYer
than
others
- Brander
et
al
(2010)
- Indirect
rather
than
direct
o Fund-­‐of-­‐funds
and
subsidies
rather
than
government
VC
funds
- Broad
rather
than
narrow
o Avoid
directed
support
to
certain
industries
/
geographies
CASE
FOR
GOVERNMENT
SUPPORT
OF
VC?

15. 15
• Later-­‐stage
private
equity
–
buyout,
infrastructure,
real
estate
funds
–
flourishing
in
Europe
- SRll
substanRal
capital,
despite
financial
crisis
- PE-­‐backed
companies
did
surprisingly
well
during
crisis
(e.g.
Hotchkiss,
Smith,
Strömberg,
2013)
• Governance
rather
than
investment
capital
- SRll,
very
important
for
restructuring
and
structural
change
- E.g.
Turnaround
funds
focusing
on
Southern
Europe
• IndicaRons
that
PE
funds
try
to
fill
debt
financing
gap
- Increasing
interest
in
raising
debt
funds
and
mezzanine
funds
replacing
bank
financing
PRIVATE
EQUITY
II:
BUYOUT
FUNDS

16. 16
• Corporate
lending
market
sRll
suffering
from
bank
balance
sheet
contracRon
• Effect
strongest
on
small,
private
firms
- Some
evidence
that
”shadow
banking”
market
is
responding
- Bond
markets,
micro
bonds,
PE
debt
funds
• Likely
that
exists
”equity
gap”
for
small,
private
firms
- Possibly
calls
for
government
intervenRon
- Should
be
indirect
rather
than
direct:
o Tax
reducRons
to
sRmulate
inside
equity
financing
o Government
FoF
for
early-­‐stage
VC
funds
CONCLUSION

17. 17
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