Dynamic Discouraged Borrowers
| Published date | 01 October 2023 |
| Author | Marc Cowling,Alex Sclip |
| Date | 01 October 2023 |
| DOI | http://doi.org/10.1111/1467-8551.12666 |
British Journal of Management, Vol. 34, 1774–1790 (2023)
DOI: 10.1111/1467-8551.12666
Dynamic Discouraged Borrowers
Marc Cowling1and Alex Sclip2
1Business School, Oxford BrookesUniversity, Oxford, OX3 0BP, UK 2Department of Business Administration,
University of Verona, Verona, 37129, Italy
Corresponding author email: mcowling@brookes.ac.uk
This paper investigates the intertemporal dynamics of borrower discouragement. Using
a cross-country panel of rms that were resurveyed across the waves of the Survey on
Access to Finance of Enterprises, we nd that the probability of transitioning into dis-
couragement changes over the business cycle and across bank nancing products: term
loans and credit lines. Past credit experiences and rm-level risk indicators are impor-
tant factors in explaining the probability of being discouraged over time. Wealso analyse
the transitioning out of discouragement, and show that rm-level improvements in credit
history and prot outlook drive the transitioning out of the discouragement state.
Introduction
Discouragement has been recognized as a widely
spread phenomenon in debt markets and this is
particularly important as access to bank term
loans and credit lines is strongly positively as-
sociated with rm value if employed intensively
(Berger et al., 2021). Previous research has shown
that discouraged borrowers are twice as prevalent
as rejected borrowers. However, until recently it
was difcult to investigate the subject as, unlike re-
jections, discouragement is largely unobservable.
The empirical literature usually takes a static ap-
proach by comparing discouraged borrowers with
applicant and non-applicant rms, implicitly as-
suming that once a discouraged borrower always
a discouraged borrower, without taking into con-
sideration the fact that the phenomenon might be
a transitory status during a rm’s lifetime. In this
paper,we overcome this limitation by trying to an-
swer the followingresearch question: how do rms
change their status into and out of discouragement
over time? To convincingly answer this question,
one needs to observe a sample of rms that are
resurveyed over time and trace back the internal
and external factors that shape the decision to not
apply because of fears of being rejected. Giventhe
fact that rms interact multiple times with their
nanciers, our idea is that discouragement arises
as a result of a learning process. Current discour-
aged borrowers, for example, might be rms that
recently applied and got their application rejected,
or can be rms that are guided by experienced
entrepreneurs rationally formalizingtheir expecta-
tions about the outcome of a loan application and
declaring discouragement.
The seminal theoretical work of Kon and Storey
(2003) explained the reasons whydiscouraged bor-
rowers exist. The theoretical model is a one-time
model in which discouraged borrowers arise be-
cause of screening errors, application costs and
the extent to which the bank interest rate differs
from that charged by the money lender. However,
in practice, the phenomenon of discouragement
is complex and might be the result of a dynamic
learning process driven by a multitude of factors.
In this paper we seek to analyse how these learning
processes adapt and occur in credit markets and
give rise to the phenomenon of discouragement.
In conducting our analysis, we also dedicate par-
ticular attention to two main factors thatshape the
phenomenon: the economic cycle and the type of
bank nancing product.
To do so, we focus on rms that were resur-
veyed multiple times in the ECB ‘Survey on Ac-
cess to Finance of Enterprises’ (SAFE) to unveil
the intertemporal dynamics of borrower discour-
agement. Using a panel regression that links past
© 2022 The Authors.British Journal of Management published by John Wiley & Sons Ltd on behalf of BritishAcademy
of Management.
This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distri-
bution and reproduction in any medium, provided the original work is properlycited.
Dynamic Discouraged Borrowers 1775
credit constraints to the probabilityof movinginto
discouragement, we show that rms that had bad
credit experiences (those thatwere partially or fully
rationed in the past) are more likely to be dis-
couraged for both term loans and credit lines. The
probability of moving into discouragement is also
linked to rm and country-level factors. Among
rm-level covariates, we noticed that age and cap-
ital are important determinants in the transition-
ing into discouragement for term loans, while for
credit lines,nancing siz e and credit history arethe
key rm-level factors. Importantly, we also show
that the dynamics change depending on the type
of nancing product – credit lines or term loans –
and during two different phases of the economic
cycle – crisis and post-crisis.
In a second step, we also unveil the transition
out of discouragement. To this end, we nd that
improvements in credit history and prot outlook
are important determinants, while previous neg-
ative experiences have no long-lasting effects on
rms’ discouragement. Importantly, we also show
that the likelihood of moving out of discourage-
ment is mostly driven byimprovements in the busi-
ness climate, which are captured by time xed
effects.
Our study contributes to the literature on bor-
rower discouragement in different ways. First, we
apply a dynamic approach which is particularly
important as rms transition from one state of en-
gaging with the market for debt into a state of
discouragement and vice versa. The typical way
to think about discouraged borrowers – as shown
in Kon and Storey (2003) – describes the phe-
nomenon as a one-stage process,without taking in
consideration the fact that discouragement might
be a result of an evolving process. Since rms inter-
act multiple times with nancial institutions when
seeking external nancing it could be that past
experiences, the recent evolution of their credit
risk prole and the economic cycle are important
in determining their willingness to put forward
new funding applications. Bad previous experi-
ences (credit denials), increased credit risk and the
evolution of the external environment might in-
crease the likelihood of transitioning from a state
where rms that need funding are willing to apply,
into a state of discouragement. Studying the phe-
nomenon by using a dynamic approach is impor-
tant for businesses and their ownersand managers,
as remaining in a state of discouragement for long
periods of time will constrain their ability to invest
in new opportunities and generate future growth.
The approach is differentfrom the recent empirical
evidence on the determinants of borrower discour-
agement (Cole and Sokolyk, 2016; Han, Fraser
and Storey,2009; Mac an Bhaird, Vidal and Lucey,
2016) and on the effect of loan application costs on
the level of discouragement (Ferrando and Mulier,
2022), but it is complementary and adds some im-
portant new insights to this body of knowledge.
Second, we apply this approach over a long
period that allows us to distinguish how the dy-
namic process evolves during the crisis and in nor-
mal times. In this regard, the literature usually fo-
cuses on short periods characterized by particular
events, such as the Global Financial Crisis (GFC)
(Cowling et al., 2016). In our work, we rely on a
longer time period, which allows us to differenti-
ate the phases of the economic cycle.
Third, we distinguish between different bank-
ing products: term loans and credit lines. Differ-
ent banking products entail different exchanges
of bank–rm information, which can shape the
propensity of moving into and out of discour-
agement. The empirical literature is less rich on
this point as it usually concentrates on the con-
text of term loans, which entail a lower exchange
of information during the lending relationship. On
the contrary, credit lines might be more strategic
for the lending partner as they might be used as
a vehicle for exchanging information and learn-
ing about how rms behave. In this regard, Berger
et al. (2021) nds a special role of credit lines in
supporting long-term rm performance and im-
proving bank–rm relationships.
From a broader perspective, our study also ts
into the debate around the availability of credit
to small and medium-sized enterprises (SMEs).
Cosh, Cumming and Hughes (2009) established
that capital is not always available to SMEs in
the form they would prefer, which may increase
discouragement, and Block et al. (2018) identi-
es signicant new players in the market for en-
trepreneurial nance which may reduce discour-
agement. Barbalau, Huson and Roth (2022) also
highlight the critical role that cash holdings play
in the bank lending process. This also relates to
wider debates around the democratization of en-
trepreneurial nance, dened as ‘the creation of
more equality regarding the access to nancial re-
sources by categories known to be underrepre-
sented among potential entrepreneurs’(Fisch, Me-
oli and Vismara, 2020: 70) and the potential for
© 2022 The Authors.British Journal of Management published by John Wiley & Sons Ltd on behalf of British
Academy of Management.
To continue reading
Request your trial