USA - The Importance of Bank Lending Relationships for Small and Medium-Sized Firms: Evidence from Norway

Our proposed research program is interdisciplinary (finance, economics, strategy and management) and studies the importance of bank finance for small and medium-sized Norwegian firms. From U.S. research, we know that small firms are especially dependent o n having a long-term bank connection (relationship): owners of small firms have to rely on bank lending and their own invested equity when financing their investments. Few other sources of finance are available to the average firm. In order to understand how small businesses grow and develop over their life-cycle, it is important to understand what is going on in the relationships they maintain with their biggest external investor--the bank. For this purpose, we want to study the extent of so-called "risk sharing" taking place between small firms and banks. Risk sharing basically means insurance. From the point of view of the firm, bank finance works as a "buffer", insulating the firm's investment and the business-owner's income and consumption from bus iness cycle fluctuations (risk). When a bank provides finance to a firm, it shares risk with the firm's owners by bearing a part of the firm's exposure to macro-economic risk. Essentially, the more a bank invests in a firm, the more of the risk is borne b y the bank as opposed to the firm's owners. Small and medium-sized businesses are important catalysts in the economy. Much of new innovation and job-creation occur in small businesses. However, small firms' investment is also especially vulnerable to bu siness cycle fluctuations and macro-economic risk. We want to examine how much of that risk is actually borne by banks in the context of lending relationships. In the first phase of the research program we intend to examine the characteristics and consequ ences of risk sharing. The objective of our analysis will be to estimate the magnitude of risk sharing and the determinants of risk sharing actually taking place between small firms and banks in Norway.