bank financing, institutions and regional entrepreneurial ... · new venture formation, we find...

1

Bank Financing, Institutions and Regional Entrepreneurial Activities: Evidence from

China

IFTEKHAR HASAN

School of Business

Fordham University

and Bank of Finland

1790 Broadway, 11th Floor

New York, NY 10019

Telephone: 646-312-8278

E-mail: [email protected]

NADA KOBEISSI

Department of Management

College of Management

Long Island University-C.W. Post

700 Northern Boulevard

Brookville, New York 11548-1326


HAIZHI WANG

Stuart School of Business

Illinois Institute of Technology

565 W Adams St.

Chicago, IL 60661

Email: [email protected]

MINGMING ZHOU

University of Colorado at Colorado Springs

College of Business and Administration

1420 Austin Bluffs Parkway

Colorado Springs, CO 80918


Corresponding author. Please send all correspondence to [email protected].

mailto:[email protected]





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Bank Financing, Institutions and Regional Entrepreneurial Activities: Evidence

from China

Abstract

In this paper, we empirically investigate the effects of bank financing on regional

entrepreneurial activities in China. We present contrasting findings on the role of quantity

vs. quality of bank financing on new small business formation in China. While we find a

consistent, significantly positive relationship between the quality of bank financing and

new venture formation, we find that the quantity of supplied credit is insignificant. We

also investigate the effects of institutional environment on new venture creation. We find

that both formal intuitions measured by rule of law and informal institutions measured by

social trust are positively correlated to regional entrepreneurial activities. We interact our

measures of bank financing with measures of formal and informal intuitions. Our findings

reveal that the institutional environment tends to supplement bank financing in the sense

that institutional environment have a strong effect on regional entrepreneurial activities

when local banking system is less efficient to screen and fund would-be entrepreneurs.

Keyword: New venture formation, Bank financing, Institutions, Rule of law, Social trust

3

1. Introduction

Entrepreneurship involves mobilizing resources in the formation of new ventures to

pursue opportunities based on commercializable innovations (Aldrich, 1990). There is a

growing sense among academic researchers that the U.S. economy especially benefits from

vibrate entrepreneurial activities, which also contribute to the rising leadership of U.S.

firms in high-technology industries. During the entrepreneurial process, resource

acquisition, especially of financial resources, is crucial for making an innovative idea into

a reality (Black and Strahan, 2002; Blinks and Ennew, 1997). When a change in the

technological regime necessitates the creation of new firms, this can happen relatively

rapidly in the U.S., where financial markets function efficiently (Acemoglu, 2001).

The role of banks in facilitating entrepreneurial activities as well as economic growth

has been well established in the existing literature (Guiso et al., 2004). Entrepreneurial

firms are generally small and depend heavily on the credit provided by local banking

systems for their start, survival and continuous growth (Cole et al., 1996; Guiso et al., 2004).

However, most of the research that investigates the effect of financial development or

banking systems on entrepreneurship focuses exclusively on countries in North America

and Europe (Black and Strahan, 2002; Blinks and Ennew, 1997; Bruton et al., 2008; Kerr

and Nanda, 2009; Wall, 2004). The exploration of related domains outside of these two

developed economic regions remains extremely limited. Therefore, it is our attempt to

contribute to the literature and provide new evidence by empirically investigating the

relation between banking institutions and entrepreneurial activities in China, one of the

largest and fastest growing transitional and emerging economies in the world.

4

Moreover, existing studies tend to resort to the quantitative side to measure the banking

sector in the economy, which emphasizes the role of banks in stimulating capital

accumulation. Compared with the environment in a developed economy, the banking

institutions in emerging countries are usually much more strictly regulated and their

lending businesses are heavily government-directed or are regulated by government

intervention (Manolova et al., 2008). More importantly, lending to small businesses

requires banks to rely more on “soft information” to make decisions whether to extend

credit to small businesses, because the “hard information” is difficult (or almost impossible)

to collect due to the small firms’ lack of bookkeeping or new establishment (Stein, 2002).

Given the complicated nature of the “soft-information” processing, a measure which is

purely based on the quantity dimension of banking practice (such as total bank loans or

credit supplies) is simply not sufficient or even appropriate to gauge whether banks are

optimizing financial resources in an economy. Therefore, it is a bit surprising how little

the existing literature interrogates the quality of bank lending matters for entreprenurial

firms; most studies view the issue as resolved upon receiving a measure of quantity.

Therefore, given the importance of qualitative dimensions of bank financing for new

ventures, and given the lack of documentation in the field, it is our intention to contribute

to the existing literature by capturing and examining both the quantity and quality sides of

bank financing, to documenting and compare their different effects on new venture

formation, and finally, to highlight the importance of these quality dimensions on the

success of new ventures.

Parallelly, another strand of research emphasizes institutional environment and its

effect on economic growth and financial development (Cull and Xu, 2005). The relation

5

between intuitional environment and financial system has raised much interests by

academics because better legal protection and institutions may lead to better outcomes for

the financial system (La Porta et al., 1998). It is crucial for policy makers, especially those

in emerging countries, to understand which factor matters more due the limited resources

and time constraints (Cull and Xu, 2005). Institutions set constraints on market

transactions and exchanges with better devised intuitional settings lowering transaction

costs and facilitating resource allocation. More recently, scholars have examined

institutional environment such as the legal and political conditions that support

entrepreneurial behavior, and encourage/discourage entrepreneurs’ risk-taking behavior

(Ebner, 2006; Eliasson and Taymaz, 2002). The institutional context defines and creates

opportunities (Baumol, 1990) by offering different payoffs to different entrepreneurial

activities. Consequently, facing different institutional environment, entrepreneurs with

different perception choose to bundle resources and pursue their entrepreneurial vision in

different ways. In this paper, we embrace the notion that difference in institutional

arrangements across regions, both formal and informal, can explain the regional difference

in the level of entrepreneurial activities.

Using country-level data, it is difficult to separate the effects of banking financing from

its associated institutional environment because external financing can be strongly

influenced by formal and informal intuitions (Johnson et al., 2002). Therefore, in this study,

we collect data at sub-nation level from different regions in a single emerging economy,

China, and construct a panel of 30 provinces in China over the period from 1998 to 2008

to ensure we have sufficient variations in both cross-sectional and time-series dimensions

to explore our research question. From various sources, we obtain information regarding

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the number small businesses, and we consider both the births and deaths of small business

to construct our measure of the entrepreneurial activities in local areas. We further measure

both the quantity and quality of bank financing to examine the role played by financial

intermediations on regional entrepreneurship. Following existing research, our quantity

measure focuses on the size of the banking sector at the province level. Our quality

measure is derived from aggregation of bank-specific efficiency scores.1 We first estimate

both profit (cost) efficiency for each individual bank, and then aggregate the bank-specific

efficiency score into province level according to a weighed scheme. In the regression

analysis, we also control for the regional economic environment and demographic

information such as provincial population, foreign direct investment, GDP per capita, local

availability of trained human capital and unemployment rate.

We document a significantly positive relation between the quality of financing services

offered by banking institutions and entrepreneurial activities in local markets. To address

the possible endogeneity issue commonly found in this type of research, we perform our

analysis based on a system GMM estimator (Bond, 2002). The results are robust to various

model specifications and identification strategies. Our analysis also reveals that both

formal and information institutions matter for new venture creation. We further interact

measures of bank financing with measures of institutional environment. Our findings

indicate the both formal and informal institutions substitute the efficiency of provincial

1 In recent years, the concept of frontier efficiency has been widely applied and documented in the banking

literature. For example, Berger and Humphrey (1997) provide a comprehensive survey of 130 studies that

apply frontier efficiency analysis to financial institutions in 21 countries, and conclude that the efficiency

studies yield important implications for financial institutions in areas of government policy, research, and

managerial performance.

7

banking sector with intuitional environment having a stronger effect of local

entrepreneurship in areas with low bank efficiency.

This study contributes to the literature in the following ways. First, we add to the

existing literature novel evidence of the effect of financial institutions and entrepreneurship

in an emerging country. Our study makes an explicit distinction between the quantity and

quality of bank financing (Koetter and Wedow, 2006; Lucchetti et al., 2001), and

investigates the relative importance of enhanced efficiency of financial intermediations

over supplied credit in promoting entrepreneurship in the local areas. Our findings

emphasize the importance of bank efficiency in funding entrepreneurial firms and highlight

the function of screening and monitoring role performed by banking institutions. Second,

we shed further light on how institutional framework affect entrepreneurship (Acs and

Karlsson, 2002; Ebner, 2006; Eliasson and Taymaz, 2002). Lastly, we contribute to the

literature by highlighting the importance of social trust on fostering regional

entrepreneurship (Casson and Giusta, 2007)d.

The rest of this paper is organized as follows. Section 2 introduces background

information on banking system and institutional environment in China and reviews related

literature. Section 3 details the data collection and our sample. Section 4 discusses our

identification strategies and reports empirical results. Section 5 summarizes and concludes.

2. Literature review

2.1 Background of institutions in China

2.1.1. Banking intuitions in China

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Emerging economies are characterized by an increasing market orientation, and are

becoming major economic forces in the world (Bruton et al., 2008). The late twentieth

century has witnessed the transformation of numerous centrally planned economies around

the world into market systems. Among many emerging countries, China has followed an

incremental and experimental path to reform its economy and has achieved fast growth

rates for more than three decades (Prasad and Rajan, 2006). During the transformational

stage, credit markets and banking system in China play a major role in channeling crucial

capital from saving to investment. Meanwhile, the banking system has continuously

undergone significant changes due to policy shifts.

The Chinese banking system was established in the late 1940s and followed the system

of the Soviet Union. The central bank, the People’s Bank of China, was founded in 1948,

and took responsibility for currency issue and monetary control. The banking system

expanded by launching several large state-owned banks that took over lending functions

from the central bank. The Chinese banking sector was dominated by four very large state-

owned banks with about three-fourths of banking assets.2 Initially, these mega banks

mainly served as “conduits” for the government, rather than as commercial banks.

Competition in the banking sector was limited because banks were lacking in sufficient

incentives to make profits out of real business lending.

It was not until in the early 1990s that the central government began to reform the

financial system by separating the policy banks from commercial banks. The 1995

Commercial Bank Law of China officially states that the major objective of state-owned

2 The “Big Four” are Bank of China (established in 1912), China Construction Bank (established in 19544),

Agricultural Bank of China (established in 1979), and Industrial and Commercial Bank of China (established

in 1984).

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banks is to operate as commercial banks in accordance with market principles instead of

according with policy requirements. In addition, de novo banks were permitted to enter

into the market in the mid-1990s. In the subsequent years, a series of procedures were

taken to transform urban credit unions into commercial banks, grant limited licenses to

non-state commercial banks as well as foreign banks, and introduce standard accounting

and prudential norms. Additional changes were implemented after China’s entry into the

WTO in 2001, including the liberalization of interest rates and a relaxation of restrictions

on equity ownership (Berger et al., 2009).

The gradual reform of the banking system in China and various regulatory changes has

significantly increased bank competitions and bank efficiency. While a flourishing

entrepreneurship in the private sector has been significant to the economic development of

China, the role of the banking sector is still inconclusive in existing literature (Hasan et al.,

2009). Given the predominant size of the banking sector in China, it would be interesting

to examine both the quantitative and qualitative sides of Chinese banks and their effects on

entrepreneurial activities.

2.1.2. Formal and informal institutions in China

The development of the modern Chinese legal system starts after the Cultural

Revolution when members of the legal profession were rehabilitated and a new state

constitution that emphasized the rule of law was enacted. Starting from 1979 and most

intensively in the 1990s, numerous legislation designed to facilitate the transition to a

“socialist market economy” was enacted. Among these legal initiatives, the most important

ones include the General Principles of Civil Law (1986), Company Law (1993, revised in

2005), Labor Law (1994, revised in 2008), Securities Law (1999, revised in 2005),

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Contract Law (1999), Patent Law (2001), Copyright Law (2001), Trademark Law (2001),

Enterprise Bankruptcy Law (2005), Property Law (2007), and Law on Scientific and

Technological Progress (2007). Administrative and judicial institutions to enforce the rules

have also been established.

As part of its economic and legal reforms, the ruling party has deliberately used

legislations and policy tools to facilitate innovation. For example, the Law on the

Promotion of Small and Medium-Sized Enterprises was promulgated in 2002 and Law on

Scientific and Technological Progress promulgated in 2007 to legalize the systematic

public support for innovation. Other than the legal initiatives from the State, different

provincial-level People’s Congress and government are decentralized with power to enact

regulations and policies conducive to innovation in their own region.

In addition to formal intuitions (legal systems), informal institutions also play an

important role in economic transactions, especially when formal intuitions are weak and

defective. In this study, we focus on a particular type of information institutions, social

trust. Sociologist often view generalized social trust as a collective characteristic of social

relations (Bourdieu, 1983; Coleman, 1988) that is influenced and sustained by cultures,

communities and social institutions. In China, the history of the impacts of social trust on

economic development in China may go back as far as Ming Dynasty. The development

of social trust has evolved over time and become an important component of the informal

institutions. Social trust can be viewed as a form of social capital (guanxi) which facilitate

smooth market exchange, enabling better enforcement and development of public

institutions and stimulating productive collective action (Algan and Cahuc, 2010; Helliwell

and D.Putnam, 1995; Knack and Keefer, 1997; Zak and Knack, 2001).

11

2.2 Related research

Banks are essential for economic development in that they are a crucial device to

screen entrepreneurs and allocate financial and real resources in an efficient way

(Diamond, 1991). As Cole et al. (1998) report using the data from 1993 National Survey

of Small Business Finance (NSSBF 1993), banks provide more than 60 percent of small

business credit. The causal relation between the financial sector and economic

development has been well established in the literature (King and Levine, 1993), which

supports a premise dating back to 1934 that a sound financial system fosters economic

growth (Schumpeter, 1934). Most of the research has been focused on the role of banks in

accumulating capital, and has employed measures such as the ratio between liquid

liabilities of the banking system and GDP (Gertler and Rose, 1994), the ratio of domestic

credit to GDP (Rajan and Zingales, 1998), and the share of credit granted to the private

sector in ratio to GDP (Beck et al., 2000; Wurgler, 2000) to gauge the size of financial

institutions.

The purpose of this article is to examine the effect of bank financing on new venture

creation (Headd and Kirchhoff, 2009) given that entrepreneurs rely significantly on bank

financing to launch new ventures to pursue their entrepreneurial vision (Alessandrini et al.,

2009). We argue that there exists a dynamic interaction between entrepreneurial firms and

financial institutions (Peng, 2003). The decision to launch new ventures is a natural

reflection of the formal and informal constraints faced by entrepreneurs in the local markets

(Barney, 1991; Teece et al., 1997). Given the limited resources of the region in which

entrepreneurial firms are competing (Aldrich, 1990), young ventures tend to be rationed

and are subject to a screen for credit worthiness and future prospects by banking

12

institutions. Moreover, local banking development can affect firms’ innovative activities,

particularly for small firms and for firms in technology sectors (Alessandrini et al., 2009;

Benfratello et al., 2008). Consequently, the entrepreneurial orientation of would-be

entrepreneurs will be shaped by the practice of financial intermediations in local areas

(Tang et al., 2008).

Although the importance of bank financing for entrepreneurship has been highlighted

in the existing literature, very few studies make a distinction between the quantity and

quality of banking institutions (Koetter and Wedow, 2010; Lucchetti et al., 2001). In this

study, it is our attempt to emphasize both the quantity and quality aspects of bank financing.

In a Schumpeterian world, the quality of bank services should matter more than just the

quantity of financial intermediation for the economic development. Stein (2002) points

out that the key distinguishing characteristic of small business lending is the “softness” of

information generated in the decision making process. Banks have an informational

advantage in identifying entrepreneurs with the highest potential to promoted innovative

products, services and processes, and thus can nurture lending relationships with

entrepreneurial firms (Berger et al., 2005). Banks in the economic system function as a

certification to the quality and viability of entrepreneurial firms and increase their

probability of successful introducing innovation to the market (Lucchetti et al., 2001;

Stiglitz and Weiss, 1988). During the lending process, banks can economize on searching

costs and thus achieve aggregate savings (Allen, 1990). As both insider lenders and

delegated monitors (Diamond, 1984, 1991), banks have access to entrepreneurial firms’

information from the onset of a loan application, as well as from previous lending

relationships, and thus are able to provide more effective monitoring at a lower cost

13

(Roberts and Yuan, 2010). Therefore, the information advantages allow local banks to

alleviate free-rider problems arising from asymmetric information and may enhance

entrepreneurial firms’ innovation activities. In China, lending to small businesses is highly

regulated by certain quotas set by the government because all the mega banks are state-

owned. As a result, banks may fund only a fraction of entrepreneurial firms with promising

prospects, and have to terminate lending relationships with some small businesses. Such

practice in China can have negative consequences for the survival and growth of small

firms with high switching cost. In other words, capital infusion by banking institutions

itself does not ensure the flourish of entrepreneurial activities (Hypothesis 1). Instead,

bank efficiency, which measures the relative ability of banks to efficiently utilize their

resources to generate outputs, may play an even more important role in allocating loanable

funds to entrepreneurs. We posit that in regions where banks are relatively more efficient

at minimizing costs when searching for promising businesses and monitoring their lending

portfolios there will be evidence of better nourished entrepreneurship and more venture

formation (Hypothesis 2).

Another strand of research emphasize the importance of intuitional framework on

entrepreneurship (Ebner, 2006; Sobel and Hall, 2008). North (1991) defines institutions

as “the humanly devised constraints that structure political, economic, and social

interaction.” Appropriate institutional settings can significantly lower transaction costs by

specifying clearly the rules of game thus reduce uncertainty in market exchanges. For

example, in a system of well-defined and protected property rights, participants know in

advance the consequences of a potential transaction to some degrees, and are able to

capture the gains from exchange.

14

Institutions can be formal, such as the enforcements of investor protection and

property rights, which set constraints on market interaction and specify associated

consequences. In his influential paper, Baumol (1990) makes distinction among productive,

unproductive and destructive entrepreneurship. He argues that the relative payoffs

provided by the institutional arrangements of the society greatly shape the distribution of

entrepreneurship. The regional differences in entrepreneurial activities can largely be

explained by the difference in institutional environment across regions (Armington and

Acs, 2002; Eliasson and Taymaz, 2002). Therefore, properly devised institutional settings

can facilitate would-be entrepreneurs to pursue their entrepreneurial visions by launching

new ventures (Hypothesis 3).

Institutions can be informal, such as, customer believe and trust. Market transactions

and exchange depend on cooperation and trust, when participants face severe asymmetric

information and only have incomplete information. Even if there is proactive enforcement

of formal institutions by regulatory agencies, neither laws nor the government can

safeguard against the temptation to engage in opportunistic behavior that may result in the

failure of efficient resources allocation in the financial market. In such circumstances, the

transactions costs can be high, which necessitate other means to overcome the difficulty in

order to complete the exchanges.

In recent research, Ang et al. (2014a) bring the social trust perspectives in China in

the literature, and argue that social trust, as a form of social capital, is indeed an important

factor for investment. In this paper, we propose social trust is part of informal intuitions,

and it complements formal institutions when there are defects in formal institutions (Ang

et al., 2014b). Existing literature has documented the importance of social trust to various

15

economic and financial outcomes (Algan and Cahuc, 2010; Zak and Knack, 2001).

According to Guiso (2012), trust means that one person or group feels comfortable to place

resources at the disposal of another person or group with the expectation that there would

be a fair payoff even without any legal commitment from the latter. Using data from four

former Soviet republics (Belarus, Kazakhstan, Russia, and Ukraine), Neace (1999) reports

that entrepreneurs unanimously claim that trust is the key factor to explain entrepreneurial

success. Therefore, we predict there is a positive relation between social trust and regional

entrepreneurship (Hypothesis 4).

While existing literature have documented that the development of both financial

sector and institutions affect entrepreneurship in a significant way, little is known regarding

the interaction between banking institutions and institutional environment (Cull and Xu,

2005). Research has found that both formal intuitions such as enforcement of intellectual

property rights (Ang et al., 2014a) and informal intuitions such as social trust (Guiso et al.,

2004) affect economic agent’s investment decisions and financial development. In this

paper, we argue the effect of bank financing will be stronger in areas with weaker

intuitional settings because banks have to allocate more resources to collect information to

identify potential small corporate customers with better prospects (Marquez, 2002).

Therefore, regions with efficient banking system are able to better nurture entrepreneurship

when formal or informal institutions are underdeveloped (Hypothesis 5).

3. Data and methodology

In a standard cross-country setting, it is very difficult to observe and control for the

set of social and cultural variables that potentially play an important role in affecting

financial intermediations. Moreover, because of the sampling procedure, researchers are

16

oftentimes forced to compare a large number of countries that possess dramatically

different legal systems and institutional settings, which play an important role in shaping

the practice of financial institutions (Manolova et al., 2008). For example, a bank’s ability

to force repayment and the cost of contract enforcement can vary widely across sample

countries. Therefore, cross-country comparisons are subject to “data comparability and

functional equivalence” (Sekaran, 1983). To reduce the sample biases, we examine the

role of bank financing in explaining entrepreneurial activities using provincial data in

China, which is one of the largest and fastest growing transitional and emerging economies

in the world. By using the sub-national level data, we are able to focus on both the quantity

and quality aspects of banking institutions in China, and we can largely avoid the data

comparability issue in cross-nation studies because many institutional factors — such as

diversity in historical experiences and cultural norms — are homogeneous for our sample

regions.

In this study, we use aggregate data at provincial level in China instead of using cross-

country samples, and construct a panel of 30 provinces (including four municipalities) in

mainland China from 1998 to 2008.3 The sub-national data we use in this paper allow us

to control for heterogeneity in historical experience and cultural norms (Hasan et al., 2009),

thus render some major advantages over cross-country studies in addressing the data

comparability issue.

3.1 Measures of regional entrepreneurial activities

3 There are 31 provinces (including four municipalities) in China. We have to omit one province (Tibet)

because of missing data. In addition, our sample period starts from 1998 because it is since then that China

began to report data on small businesses using on consistent definitions, which is discussed in more detail in

Section 3.1

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Aldrich (1990) argues that there is a significant shift from “traits” approach to “rates”

approach in entrepreneurship research, the latter of which emphasizes the founding rates

of new businesses over time Firm birth rates are widely adopted in recent studies to

investigate entrepreneurial activities and the related determining factors (Francis et al.,

2008; Kirchhoff, 1994; Kirchhoff et al., 2007). However, another important aspect of

entrepreneurship has largely been ignored in empirical studies (Birley, 1986; Delacroix and

Carroll, 1983), which highlights the importance of firm death rates in subsequent new

venture formations. Given that environmental resources set a limit on population density,

entrepreneurial activities vary substantially in local markets because the number of

organizations competing for the same pool of resources is constrained. New business

founding rates can be affected firm death rates because resources may be available when

firm deaths dissolve and release them (Aldrich, 1990). Therefore, in our paper, we consider

not only the founding rates but also the death rates in order to capture the dynamics of

entrepreneurship in local markets.

The National Bureau of Statistics of China (NBSC) provides various statistics on the

number of firms in different sized categories at the provincial level in their yearbook.

However, before 1997, the industrial statistics were based on types of ownership, and it is

not until 1998 that the calibration of industrial statistics was changed from the types of

ownership to the sizes of enterprises. Therefore, we are able to obtain aggregate

information at the provincial level on a consistent definition of small businesses after 1998.

And we define a measure capturing the net birth rate of new ventures in each province as

follows:

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Net birth rate of new ventures it = %1001

1

it

itit

N

NN ...................................................(1)

We recognize that this measure is not perfect, but is the best available proxy to our

knowledge.

3.2 Measures of quantity and quality of bank lending

3.2.1 Quantity of bank lending

The reform of the banking sector in China began in the 1980s with an effort to

separate commercial banking from state budget allocation (Berger et al., 2009). The ratio

of total bank loans to GDP is commonly used in the banking literature as a proxy for

banking sector depth, which measures the role and importance of financial intermediation

in the economy (Berger et al., 2004; King and Levine, 1993a; Levine, 1997; Levine et al.,

2000). We obtain the regional banking loans data from the annual issues of the Almanac

of China’s Finance and Banking (ACFB), and collect GDP data from the annual issues of

China Statistical Yearbook. Following existing literature, we measure the quantity of bank

lending as the ratio of total loans outstanding at the end of the year in the balance sheet of

all banking institutions to total GDP in the region (termed as “total bank loans/GDP”).

3.2.2 Quality of bank lending

Prior studies have well established that bank efficiency better measures the quality of

banking lending because it is a more comprehensive measure than some purely balance-

sheet measures such as nonperforming loan ratio or loan loss provision ratio (Berger and

DeYoung, 1997; Berger and Mester, 1997). Therefore, we measure the quality of bank

financing using two metrics based on the stochastic frontier approach of bank efficiency

estimations from both profit maximization and cost minimization perspective. Cost and

19

profit efficiency measure how well a bank is predicted to perform relative to a “best-

practice” bank producing the same outputs under the same environmental conditions. More

specifically, we estimate efficiency levels first at firm-year level by specifying the

commonly-used trans-log functional form based on the stochastic efficiency frontier

approach (Berger et al., 2009). For convenience, we show only the cost function:

4

1

4

1

4

1

2

1

303 )/ln()/ln()/ln(2

1)/ln()/ln(

j j k l

itllitkitjjkitjjit wwzyzyzyzwC

4

1

2

1

3

2

1

2

1

33 )/ln()/ln()/ln()/ln(2

1

j l

itlitjjl

l m

itmitllm wwzywwww

+ year dummies itit lnln … (2)

where i, t index the bank and year, respectively, k = 1,…4 index the four output variables,

and δ j k ≡ δ k j. C represents the bank’s total costs. The inputs and outputs in the function

are defined in the following: four outputs including: y1 (total loans), y2 (total deposits), y3

(liquid assets), y4 (other earning assets); three inputs including : w1 (price of funds, i.e., the

ratio of interest expenses to total deposits), w2 (price of fixed capital, i.e., the ratio of other

operating expenses to fixed assets), w3 (price of labor, i.e., the ratio of personnel expenses

to total number of employees); and finally, one fixed input (z): total assets. We estimate

the cost function using the itit lnln as a composite error term, where the

itln term

represents a bank’s efficiency, and itln is a random error that incorporates both

measurement error and luck. In other words, a bank’s cost efficiency score is determined

by comparing its actual costs to best-practice minimum costs to produce the same output

under the same conditions using estimates of the efficiency factor itln , which is based on,

in our case, the assumptions of half-normal distributions, and is disentangled from the

estimated cost function residuals using maximum likelihood estimations.

After the firm-level bank efficiency is estimated, we aggregate it to the provincial

level by calculating the provincial level weighted average bank efficiency scores, where

20

the weights are the proportion of total loans by each bank to total loans in the province

(Hasan et al., 2009).4 More explicitly, we have

Banking profit (cost) efficiency j, t =

n

i

titjig1

,,, ......................................................... (3)

and

n

i

tji

tji

tji

L

Lg

1

,,

,,

,, ....................................................................................................... (4)

In equations (3) and (4), j indexes the jth province in our sample, and equals to 1, 2,…,

30. i indexes the ith bank in our sample, and equals to 1, 2, …, maximum number of banks

in jth province. t indexes year, and equals to 1998, 1999, …, 2008. gi,j,t indexes the weight

of ith bank in jth province in year t. Li,j,t indexes the total loans provided by ith bank to jth

province in year t. ti, is the efficiency score estimated based on equation (3) for ith bank

in year t.

3.3. Measuring institutional environment

Formal and informal institutions are measured at the province-level in this study and

are collected from various sources of surveys, yearbooks, and hand collections. The use

of province-level measures of institutions allows us to explore the heterogeneities of

regional institutional environment within a homogenous constitutional, cultural, and

historical framework that defines a nation (Cull and Xu, 2005; Hasan et al., 2009).

In this study, we focus on legal institutions to construct our measure of formal

institutions. La Porta et al. (1998) stress the importance of legal rules because the quality

of legal institutions determines how well investors are protected and therefore determines

the cost of financing, and plays play a crucial role in firms’ growth and performance (Beck

4 For details of the profit and cost efficiency estimations, please see Berger et al. (2009). For details of

aggregating the firm-level efficiency scores to the province level, please see Hasan et al. (2009).

21

et al., 2003).. While the law of property rights protection is enacted at national level in

China, the perceptions and enforcement of property right protection may vary significantly

across provinces because of local protectionism and the local quality of the legal

institutions. We use an index constructed by Fan et al. (2011) as a broad proxy for legal

institutions. Specifically, rule of law is a composite index measuring the development of

intermediary market, protection of producers’ legitimate rights and interests, and protection

of intellectual property.

Our proxy for informal institutions emphasizes social trust which is closely related

to the concepts of social capital and social network. However, social trust is more of a

macro measure that is inherent in the local culture and less subject to the endogeneity issue.

In particular, our measure of social trust is based on the China General Social Survey

conducted in 2013. In the survey, questionnaires were sent to more than 15,000 managers

from companies located in 31 provinces (response = 4,600). The level of provincial

trustworthiness assessed from managers’ responses to the question: “According to your

experience, could you list in order the top five provinces where the enterprises are most

trustworthy?” There are five choices for this question: “do not trust greatly”=1; “do not

trust”=2; “neutral”=3; “trust” =4; and “trust greatly”=5. We calculate a provincial-level

social trust measure by taking the average scores of this question at the provincial level.

3.4. Other control variables

In the regression analysis, we collect data from the annual issues of the Statistics

Yearbook of China to control for a set of variables capturing various aspects of regional

development that may affect entrepreneurial activities. To be specific, we measure the

natural logarithm of provincial population to control for the size of each province. Given

22

that foreign direct investment (FDI) may stimulate small businesses (Aitken and Harrison,

1999) or discourage entry of local firms (Backer and Sleuwaegen, 2003), we measure FDI

to GDP (FDI/GDP) to control for the possible effect of FDI on new venture formation.

Armington and Acs (2002) document the positive relationship between college graduates

and the number of newly formed firms. Following their method, we calculate the

proportion of population with college degrees, and use this to proxy for the availability of

trained human capital in the local areas. We also measure the real GDP per capita to control

for regional economic development momentum. In addition, we include provincial

unemployment rate as a control for local business environment. The inclusion of these

control variables are based on the natural link between broader economic development and

new business formation discussed earlier.

Table 1 presents the summary statistics and pairwise correlation matrix of the

variables used in regression analysis. We note that the average net birth rate of new

ventures is 7.4% with a standard deviation of 14.8% during the sample period from 1998

to 2008. We document that the ratio of bank loans to GDP (i.e., our measure of the quantity

of bank financing) is negatively correlated with net birth rate, while our measure of

provincial level bank efficiency is positively correlated with firm birth rate. In addition,

our measures of formal intuitions (rule of law) and informal intuitions (social trust) are

both positively correlated with net birth rate of new ventures.

[Insert Table 1 about here]

4. Empirical findings

While correlation analysis reveals certain patterns relating regional entrepreneurial

activities to bank financing, these results do not take into account potentially significant

23

differences in economic environment and other demographic characteristics. We employ

regression analysis to investigate the effect of both quantity and quality of bank financing

as well as intuitional environment on new venture formation while controlling for a set of

variables capturing various economic conditions in the local markets.

4.1. Basic regress relating bank financing to regional entrepreneurial activities

In this section, we report regression results relating bank financing to regioinal

entrepreneurial activities. Though we have a panel data covering 30 provinces from 1998

to 2008, we do not provide fixed effects regression results for two reasons. Fixed effects

regression rely on within group variations to explain variations in the dependent measure.

Nonetheless, measures of bank financing and institutional environment presents less

variation for a particular province over time, thus raise the issue of multicollinearity if we

also include state dummies in the regression analysis.5 Additionally, as Petersen (2009)

points out, estimates of standard errors by OLS with a firm fixed effect are biased when

the residuals are highly correlated over time within a cluster. Therefore, we instead report

results based on pooled OLS regressions with standard errors clustered by province. In

addition, we include year fixed effects to control for economic-wide shocks and timely

trends in all model specifications.

Table 2 presents regression results based on pooled OLS regression with clustered

standard errors by province and year fixed effects. In columns 1-3, the dependent variable

is net birth rate of new ventures. The result in column 1 reveals that the ratio of bank loans

to GDP is not significantly associated with the net birth rate of new ventures. We then turn

5 Note that our measure of social trust is a constant for a particular province.

24

to our measure of the quality of bank financing (column 2) and document that bank

efficiency of the regional banking system is significantly and positively associated with

new venture formation (p<0.01). In column 3, we enter both quantity and quality measures

of bank financing and only bank efficiency is significant. In columns 4-5, we include an

additional explanatory variable, the lagged net birth rate, to capture the dynamics in local

entrepreneurial activities. Consequently, the interpretations of coefficients of other

included independent variables are conditional on the net firm births in the previous year.

We find similar results as documented in columns 1-3. Taken together, the results indicate

that the quality of bank financing matters for new venture creation in local markets, yet the

quantity of bank financing is not.

At first glance, the results on the quantities of bank loans seem contradictory to

previous findings (Berger and Udell, 2006). Note that an important characteristic of

Chinese banking is that the majority of the loans were directed by the government toward

large and state-owned enterprises, which suffer from the soft-budget problem due to lack

of effective governance mechanisms. Our measure of the size of banking institutions is

essentially a measure based on loan size for which supplied credits to both large enterprises

and small businesses are included. Consistent with prior research on bank loans in China

(Aziz and Duenwald, 2002; Boyreau-Debray, 2003), our results support the non-positive

role of private debts on economic development. In addition, the findings reported in this

section are consistent with results reported by Koetter and Wedow (2010) using Germany

data, which emphasize the significant and positive role of quality measure of bank

financing on growth.

25

The "sound financial system" concept developed by Schumpeter focuses on the quality

rather than the quantity of financial intermediations that influences economic activities

(Schumpeter, 1934, 1939). We derive our measures of the quality of financial

intermediations to assess banks’ abilities to convert inputs into financial products and

services, and then aggregate the measures into regional levels to reflect the overall

efficiency of banking system in a particular province. Using information in column 2, we

estimate that, all else being equal, an increase in bank efficiency by one standard deviation

results in an increase of 3.6 percent of the net birth rate of new ventures, which is

economically significant. Our results reveal that improved quality of intermediation in a

bank-based economy helps to reduce transactional and informational costs in lending to

opaque corporate customers, and thus fosters new venture formation in local markets.

Regarding other control variables, we find that logged provincial population and

FDI/GDP are significantly positively associated with regional entrepreneurial activities.


Different regions may possess different endowments thus present various levels of

attraction to entrepreneurship (Rajan and Zingales, 1998). Therefore, we partition our

sample according to net birth rate of new venture creations, and examine the effects of bank

financing on new venture creation in regions with active entrepreneurial activities (net birth

rate above median) and in regions with inactive entrepreneurial activities (net birth rate

below median). We report our analysis in Table 3 for two subsamples. Although the

quantity of bank financing appears to be insignificant for overall sample, it has a positive

effect of new venture creation in regions with active entrepreneurial activities (columns 1

and 3). In contrast, we find that bank efficiency, our measure of the quality of bank

26

financing, matters more in regions that are less attractive to would-be entrepreneurs

(columns 3 and 6).


In the finance-growth literature, it is crucial to investigate whether the explanatory

variables can be treated as exogenous or endogenous in order to make causal inference

(Boyd and Smith, 1996). For example, Robinson (1952) argues that financial services are

provided as a reaction to the demand by the corporate sector (i.e., reverse causality), and

therefore, finance follows entrepreneurial activity. For another instance, it is plausible that

some unobservable factors are correlated with independent variables included in the model

specifications, especially when the unobservables are not time invariant and cannot be

accounted for by adding province fixed effects. To address the endogeneity issue, we

employ an alternative econometric procedure to instrument the independent variables that

are subject to the endogeneity problem. We use the system Generalized Method of

Moments (GMM) approach developed by Arellano and Bover (1995) and Blundell and

Bond (1998) to analyze the dynamic panel data. By first-differencing both sides of the

estimating equation, we are able to remove the individual province fixed effects and reduce

the potential source of omitted variable problem. In addition, the system GMM enables us

to instrument predetermined and endogenous variables by their own lagged levels in order

to obtain consistent estimators (Arellano and Bond, 1991). The lagged dependent variable

is entered into the right side to capture the dynamic nature of entrepreneurial activities.

This method can mitigate potential problems of serial correlation in error terms and the

correlation between the lagged dependent variable and the error terms.

27

In general, we find that the results based on system GMM estimators are consistent

with our findings reported in previous section. The overall fit of the model suggested by

Wald test statistic (p<0.05) indicates that our model is well specified. Moreover, the

insignificant Sargan test further validates that the choice of instruments is appropriate. It

is arguable that lagged levels can be poor instruments of endogenous variables. The lack

of significance of first-order autocorrelation indicates some variables follow random walks,

and consequently, our approach will be inadequate for model identification. In addition,

the presence of significant second-order autocorrelation suggests some instruments are in

fact endogenous. We thereby report the Arellano-Bond tests for autocorrelation. As shown

in Table 4, the significant first-order autocorrelation and insignificant second order

autocorrelation indicate that our models are appropriate.


4.2. Institutional environment to regional entrepreneurial activities

In Table 5, we consider both formal institutions (rule of law) and informal institutions

(social trust), and report regression results relating institutional environment to regional

entrepreneurial activities. In columns 1 and 3, we focus on the development of

intermediary market, protection of producers’ legitimate rights and interests, and protection

of intellectual property, and relate the legal environment to regional entrepreneurial

activities. In line with our expectation, we document a significantly positive effect of rule

of law on net birth rate of new ventures, and the finding is robust to both pooled OLS

estimation (column 1) and GMM estimation (column 3). Similarly, we document a positive

effect of social trust on new venture creation in columns 2 and 4. Our results lend strong

support to the notion that institutions, formal and informal, influence economic growth

28

through their effect on entrepreneurship. In addition, the persistence of regional difference

in institutional environment appears to explain a significant portion of variation in

entrepreneurship.


4.3. The effect of interactions of bank financing and intuitional environment on regional

entrepreneurial activates

In this section, we consider the interaction of bank financing and institutions and

investigate its effect on entrepreneurship. We predict that efficient bank system takes the

major responsibility of channeling productive resources to entrepreneurship when

institutional settings are weaker in some regions. To test our hypothesis, in Table 6, we

enter our measures of bank financing and institutions along with their interaction terms in

the model specifications. We find the first-order effects of banking financing and

institutions maintain their sign and significance. The coefficients of the interaction term

between measures of bank financing and formal and informal intuitions have a significant

and negative sign. Consistent with our prediction, findings reported in this section indicate

that, to facilitate entrepreneurial activities, the screening and monitoring role played by

bank intuitions matters more in regions with more efficient banking system when local

institutions are underdeveloped. Thus, our results from an emerging country add further

evidence to the literature investigating the effect of intuitions on financial development and

economic growth (Ang et al., 2014a; Cull and Xu, 2005; Guiso et al., 2004)


5. Summary and conclusion

29

Entrepreneurs have innovative ideas but lack capital, and tend to be commercially

inexperienced. Banking institutions play an important role in channeling resources to fund

would-be entrepreneurs and building up lending relationships with entrepreneurial firms.

This is particularly true in emerging countries when entrepreneurs are financially

constrained and have limited access to external financing, especially when they lack track

records or assets-in-place as collaterals. In this paper, we focus on a single emerging

country, China, to investigate the effects of banking system on regional entrepreneurial

activities. More important, we make a distinction between the quantity and quality of bank

financing and compare the effects of these distinct features on new business formation. We

further examine both the formal and informal institutions and their effects on

entrepreneurship because intuitions are equally important to channel resources to

productive entrepreneurship (Baumol, 1990).

Using a panel of provincial-level data from 1998 to 2008, we find that, overall, the

quality of bank financing matters more in nourishing entrepreneurship in local markets.

Our results indicate that in a developing economy, the efficiency of financial

intermediations can be extremely important in identifying new ventures with promising

prospects and help entrepreneurs to start their businesses. We further confirm the positive

effects of formal and informal institutions on regional entrepreneurship. Strikingly, our

analysis indicate that efficient banking system appears to complement development of

intuitions in the sense that, in regions with weaker institutional environment, the effect of

bank financing on net birth rate of new ventures is stronger.

30

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Table 1. Descriptive statistics and correlation matrix of variables used in the analysis

This table presents the descriptive statistics and pairwise correlation matrix of the variables used in the regression analysis. Net birth rate is calculated as the percentage

changes in total number of small businesses (defined as firms with fewer than 300 employees). Bank Loans/GDP is defined as the ratio of total loans by all banking

institutions to total GDP. Profit (cost) efficiency of banks is the province-level aggregated number of firm-level bank profit (cost) efficiency. Rule of law is a composite

index measuring the development of intermediary market, protection of producers’ legitimate rights and interests, and protection of intellectual property. Social trust

measures the “generalized trust” at provincial level which is derived from the China General Social Survey in 2013. LogPopulation is the natural logarithm of

provincial population GDP per capita growth is defined as the real-term GDP growth per capita. FDI/GDP is defined as the ratio of foreign direct investment to GDP.

Proportion of population with college degrees is defined as the proportion of population with college degree or high education to total population above age six.

Unemployment rate measures province-level unemployment rate. All the variables are measured at province level.

N Mean St. Dev 1 2 3 4 5 6 7 8 9 10

1 Net birth rate 310 0.074 0.148 1.000

2 Bank loan/GDP 310 1.098 0.554 -0.027 1.000

3 Bank efficiency 278 0.453 0.068 0.013 -0.026 1.000

4 Rule of law 310 5.199 3.191 0.348 0.206 0.048 1.000

5 Social trust 310 2.977 1.095 0.239 0.204 0.026 0.718 1.000

6 LogPopulation 279 8.031 0.886 0.295 -0.197 -0.048 0.139 0.408 1.000

7 GDP per capita 279 0.109 0.049 0.251 0.000 -0.086 0.143 -0.017 -0.010 1.000

8 FDI/GDP 269 0.025 0.025 0.100 0.114 0.020 0.553 0.571 -0.036 -0.111 1.000

9 College degree/Population 279 0.059 0.044 0.128 0.439 -0.002 0.638 0.568 -0.205 0.094 0.324 1.000

10 Unemployment rate 279 0.093 0.048 0.067 -0.428 -0.073 -0.439 -0.538 0.290 0.045 -0.356 -0.839 1.000

35

Table 2. Basic regression relating bank financing to regional entrepreneurial activities

This table presents regression results relating bank financing to regional entrepreneurial activities. Net birth rate is

calculated as the percentage changes in total number of small businesses (defined as firms with fewer than 300

employees). Bank Loans/GDP is defined as the ratio of total loans by all banking institutions to total GDP. Profit

(cost) efficiency of banks is the province-level aggregated number of firm-level bank profit (cost) efficiency.

LogPopulation is the natural logarithm of provincial population GDP per capita growth is defined as the real-term

GDP growth per capita. FDI/GDP is defined as the ratio of foreign direct investment to GDP. Proportion of population

with college degrees is defined as the proportion of population with college degree or high education to total

population above age six. Unemployment rate measures province-level unemployment rate. All the variables are

measured at province level.

Independent variables Dependent variables: Net birth rate

(1) (2) (3) (4) (5) (6)

Net birth rate (lagged) 0.340*** 0.346*** 0.348***

(0.069) (0.073) (0.072)

Bank loan/GDP 0.007 0.006 0.003 0.001

(0.007) (0.008) (0.006) (0.007)

Bank efficiency 0.528*** 0.523*** 0.560*** 0.559***

(0.186) (0.187) (0.140) (0.141)

LogPopulation 0.035*** 0.034*** 0.035*** 0.025** 0.025** 0.025**

(0.010) (0.010) (0.010) (0.011) (0.010) (0.010)

Per capita GDP 0.270 0.239 0.241 0.228 0.195 0.195

(0.179) (0.168) (0.170) (0.157) (0.147) (0.148)

FDI/GDP 0.749*** 0.776*** 0.767*** 0.671** 0.681*** 0.683***

(0.242) (0.238) (0.242) (0.261) (0.262) (0.262)

College degree/Population 0.117 0.091 0.076 0.095 0.060 0.054

(0.302) (0.322) (0.322) (0.285) (0.296) (0.298)

Unemployment rate 0.171 0.145 0.156 0.229 0.215 0.216

(0.285) (0.291) (0.292) (0.287) (0.290) (0.291)

Constant -0.510** -0.745*** -0.763*** -0.449* -0.716*** -0.718***

(0.251) (0.265) (0.245) (0.259) (0.270) (0.269)

Year fixed effects Yes Yes Yes Yes Yes Yes

Clustered standard errors Province Province Province Province Province Province

Observations 296 296 296 269 269 269

F-statistic 12.88*** 11.84*** 11.93*** 12.88*** 17.50*** 16.66***

Adjusted R-square 0.410 0.425 0.423 0.480 0.496 0.502

Notes: Robust standard errors are corrected for province-level clustering and heteroskedasticity, and reported in

parentheses. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

36

Table 3. Bank financing and entrepreneurship: regions with active and inactive

entrepreneurial activities

This table presents regression results relating bank financing to regional entrepreneurial activities. In particular, we

partition our sample according to the new firm net birth rate, with regions with active (inactive) entrepreneurial

activities being those provinces having above (below) median net birth rate. Net birth rate is calculated as the

percentage changes in total number of small businesses (defined as firms with fewer than 300 employees). Bank

Loans/GDP is defined as the ratio of total loans by all banking institutions to total GDP. Profit (cost) efficiency of

banks is the province-level aggregated number of firm-level bank profit (cost) efficiency. LogPopulation is the natural

logarithm of provincial population GDP per capita growth is defined as the real-term GDP growth per capita.

FDI/GDP is defined as the ratio of foreign direct investment to GDP. Proportion of population with college degrees

is defined as the proportion of population with college degree or high education to total population above age six.

Unemployment rate measures province-level unemployment rate. All the variables are measured at province level.


Regions with active entrepreneurial

activities: Net birth rate>median

Regions with inactive entrepreneurial

activities Net birth rate<median

(1) (2) (3) (4) (5) (6)

Bank loan/GDP 0.010** 0.010* -0.008 -0.019

(0.005) (0.005) (0.018) (0.017)

Bank efficiency 0.105 0.100 0.437*** 0.464***

(0.170) (0.169) (0.160) (0.164)

LogPopulation -0.000 -0.000 0.001 0.027*** 0.026*** 0.024**

(0.012) (0.012) (0.012) (0.010) (0.009) (0.009)

Per capita GDP 0.085 0.079 0.076 -0.076 -0.073 -0.066

(0.166) (0.164) (0.167) (0.113) (0.121) (0.124)

FDI/GDP 0.179 0.184 0.196 0.573*** 0.550*** 0.543***

(0.343) (0.347) (0.350) (0.194) (0.186) (0.189)

College degree/Population -0.146 -0.090 -0.148 0.213 0.140 0.206

(0.453) (0.460) (0.461) (0.279) (0.279) (0.275)

Unemployment rate -0.236 -0.234 -0.234 0.228 0.237 0.218

(0.398) (0.399) (0.400) (0.245) (0.241) (0.243)

Constant 0.323 0.273 0.264 -0.489** -0.719*** -0.674***

(0.374) (0.380) (0.380) (0.229) (0.225) (0.232)

Year fixed effects Yes Yes Yes Yes Yes Yes

Clustered standard errors Province Province Province Province Province Province

Observations 150 150 150 143 143 143

F-statistic 8.4*** 6.4*** 7.73*** 2.54*** 3.26*** 3.12***

Adjusted R-square 0.414 0.411 0.415 0.278 0.312 0.315



37

Table 4: Bank financing to regional entrepreneurial activities: Dynamic panel estimation

This table presents regression results relating bank financing to regional entrepreneurial activities using GMM

estimation. Net birth rate is calculated as the percentage changes in total number of small businesses (defined as firms

with fewer than 300 employees). Bank Loans/GDP is defined as the ratio of total loans by all banking institutions to

total GDP. Profit (cost) efficiency of banks is the province-level aggregated number of firm-level bank profit (cost)

efficiency. LogPopulation is the natural logarithm of provincial population GDP per capita growth is defined as the

real-term GDP growth per capita. FDI/GDP is defined as the ratio of foreign direct investment to GDP. Proportion

of population with college degrees is defined as the proportion of population with college degree or high education to

total population above age six. Unemployment rate measures province-level unemployment rate. All the variables

are measured at province level.


(1) (2) (3)

Net birth rate (lagged) 0.336*** 0.345*** 0.348***

(0.055) (0.055) (0.055)

Bank loan/GDP 0.002 0.000

(0.006) (0.007)

Bank efficiency 0.615*** 0.604***

(0.191) (0.190)

LogPopulation 0.025** 0.025*** 0.025***

(0.010) (0.009) (0.009)

Per capita GDP 0.229 0.192 0.192

(0.163) (0.147) (0.147)

FDI/GDP 0.673*** 0.684*** 0.684***

(0.188) (0.176) (0.177)

College degree/Population 0.103 0.055 0.055

(0.198) (0.228) (0.232)

Unemployment rate 0.228 0.214 0.214

(0.167) (0.193) (0.193)

Constant -0.447** -0.743*** -0.744***

(0.174) (0.207) (0.208)

Year fixed effects Yes Yes Yes

Clustered standard errors Province Province Province

Observations 269 269 269

Wald chi-square 642.59*** 512.49*** 563.21***

Arellano-Bond test for AR(1): p-value 0.001 0.001 0.001

Arellano-Bond test for AR(2): p-value 0.595 0.558 0.561

Sargan test of over identification: p-value 0.234 0.33 0.314



38

Table 5. Regression relating institutional environment to regional entrepreneurial activities

This table presents regression results relating institutional environment to regional entrepreneurial activities using

both OLS and GMM estimations. Net birth rate is calculated as the percentage changes in total number of small

businesses (defined as firms with fewer than 300 employees). Bank Loans/GDP is defined as the ratio of total loans

by all banking institutions to total GDP. Profit (cost) efficiency of banks is the province-level aggregated number of

firm-level bank profit (cost) efficiency. Rule of law is a composite index measuring the development of intermediary

market, protection of producers’ legitimate rights and interests, and protection of intellectual property. Social trust

measures the “generalized trust” at provincial level which is derived from the China General Social Survey in

2013.LogPopulation is the natural logarithm of provincial population GDP per capita growth is defined as the real-

term GDP growth per capita. FDI/GDP is defined as the ratio of foreign direct investment to GDP. Proportion of

population with college degrees is defined as the proportion of population with college degree or high education to

total population above age six. Unemployment rate measures province-level unemployment rate. All the variables

are measured at province level.


OLS GMM

(1) (2) (3) (4)

Net birth rate (lagged) 0.332*** 0.322***

(0.054) (0.055)

Rule of law 0.007* 0.006**

(0.004) (0.003)

Social trust 0.026** 0.019**

(0.012) (0.008)

LogPopulation 0.027** 0.012 0.019* 0.009

(0.013) (0.016) (0.010) (0.012)

Per capita GDP 0.278 0.246 0.234 0.212

(0.189) (0.189) (0.158) (0.160)

FDI/GDP 0.475 0.416 0.379* 0.402*

(0.294) (0.261) (0.215) (0.236)

College degree/Population -0.128 -0.136 -0.095 -0.082

(0.326) (0.323) (0.274) (0.233)

Unemployment rate 0.122 0.325 0.218 0.352

(0.298) (0.292) (0.193) (0.196)

Constant -0.400 -0.513* -0.393** -0.475***

(0.271) (0.252) (0.196) (0.176)

Year fixed effects Yes Yes Yes Yes

Clustered standard errors Province Province Province Province

Observations 296 296 269 269

F-statistic/Wald chi-square 17.19*** 17.85*** 469.84*** 604.96

Adjusted R-square 0.418 0.422

Arellano-Bond test for AR(1): p-value 0.001 0.001

Arellano-Bond test for AR(2): p-value 0.543 0.594

Sargan test of overidentification: p-value 0.240 0.218



39

Table 6 Interacting bank financing and institutional environment

This table presents regression results investigating the effect of interaction of bank financing and instructional

environment on regional entrepreneurial activities. Net birth rate is calculated as the percentage changes in total

number of small businesses (defined as firms with fewer than 300 employees). Bank Loans/GDP is defined as the

ratio of total loans by all banking institutions to total GDP. Profit (cost) efficiency of banks is the province-level

aggregated number of firm-level bank profit (cost) efficiency. Rule of law is a composite index measuring the

development of intermediary market, protection of producers’ legitimate rights and interests, and protection of

intellectual property. Social trust measures the “generalized trust” at provincial level which is derived from the China

General Social Survey in 2013. LogPopulation is the natural logarithm of provincial population GDP per capita

growth is defined as the real-term GDP growth per capita. FDI/GDP is defined as the ratio of foreign direct investment

to GDP. Proportion of population with college degrees is defined as the proportion of population with college degree

or high education to total population above age six. Unemployment rate measures province-level unemployment rate.

All the variables are measured at province level.


(1) (2)

Bank loan/GDP 0.136* 0.068*

(0.067) (0.039)

Bank efficiency 0.890*** 1.014***

(0.260) (0.347)

Rule of law 0.073***

(0.024)

Social trust 0.116**

(0.042)

Bank loan/GDP × Rule of law -0.022**

(0.009)

Bank loan/GDP × Social trust -0.023*

(0.014)

Bank efficiency × Rule of law -0.089**

(0.040)

Bank efficiency × Social trust -0.159**

(0.076)

LogPopulation 0.039*** 0.025

(0.011) (0.015)

Per capita GDP 0.202 0.196

(0.174) (0.168)

FDI/GDP 0.425 0.469*

(0.315) (0.267)

College degree/Population 0.573 0.154

(0.384) (0.423)

Unemployment rate 0.457 0.204

(0.295) (0.346)

Constant -1.399*** -1.055***

(0.313) (0.329)

Year fixed effects Yes Yes

Clustered standard errors Province Province

Observations 296 296

F-statistic 21.82*** 20.81***

Adjusted R-square 0.458 0.438



bank financing, institutions and regional entrepreneurial ... · new venture formation, we find...

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