Verifying the state of financing constraints: Evidence from U.S. business credit contracts

Many policymakers are concerned that tight financing constraints for small businesses are stalling the recovery from the Great Recession. This paper empirically assesses two agency problems that induce such financing constraints-one resulting in a “firm balance sheet channel” and one resulting in a “bank balance sheet channel”. Evaluating specific models of these two agency problems against a comprehensive data set of U.S. small business credit contracts, I find strong support for the firm balance sheet channel but only weak support for the bank balance sheet channel. A complementary regression analysis confirms this result. Hence, policies seeking to improve firms' balance sheets may be desirable to support small business lending in the recovery from the Great Recession.