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Weekly UpdatesIt is argued that networking is crucial for small and medium-sized enterprises (SMEs), particularly in emerging economies as they seek to access resources for development. One key resource in emerging economies is bank financing. In this paper, we develop a model that examines the net effect of different network ties on bank financing to private SMEs. The results support our hypothesis that different network ties influence SMEs' use of bank loans in different ways. Specifically, networking with customers and government officials promotes the use of bank loans, while networking with suppliers and social ties reduces the need for bank loans. This study provides a number of research and managerial implications, which are discussed at the end of the paper.
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Entrepreneurship has been an engine of sustained economic expansion in both developed and emerging economies (e.g., Baumol, 2002; Peng, 2001; Smallbone & Welter, 2001; Thornton, 1999). One critical success factor for entrepreneurial firms is gaining sufficient access to external sources of finance (Ahlstrom & Bruton, 2006; Le, Venkatesh, & Nguyen, 2006). This is particularly true in emerging economies because such resources are severely constrained. For example, capital markets, venture capital, and angel investors are typically at nascent stages of development. As such, bank loans tend to be the only significant formal sources of external funding for private small and medium-sized enterprises (SMEs) in emerging economies. Therefore, a key challenge for many entrepreneurs is to find a means of accessing bank loans efficiently.
From the perspective of commercial banks, lending to SMEs is perceived to be risky. But such lending is even more challenging for banks in emerging economies because the institutional environment is less developed. Banks rely on stable market institutions such as auditable business information with predictable rule of law that is enforceable to ensure repayment of their loans in some form (Nguyen, Le, & Freeman, 2006; O'Connor, 2000). Institutional stability and predictability reduces risks and uncertainty, and enhances the probability of loan success (that the principal and interest on the loan will be paid back, in full, and on time). Such market institutions, however, are often absent in emerging economies (Ahlstrom & Bruton, 2006; Nguyen, Weinstein, & Meyer, 2005; Peng, 2003). In these countries, uncertain property rights, vague laws and unpredictable law enforcement, and unavailable business data all combine to reduce the ability for local banks to emulate the practices applied by banks in developed countries. As a result, banks in emerging economies have to adjust, or rely on different lending practices (O'Connor).
If banks in emerging economies apply different lending practices, then firms borrowing from these banks also need to tailor their practices accordingly. However, empirical studies of SME bank financing in emerging economies are sparse (Cook, 2001). Instead, most studies on bank financing of SMEs examine firms in business environments that have clear property rights, as well as developed market and regulatory infrastructures, which are often less robust or almost absent in emerging economies (Ahlstrom & Bruton, 2006; Nguyen et al., 2005; Peng, 2003).
In emerging economies, personal relationships and networks are often seen as an effective substitution for well-established institutions (Ahlstrom & Bruton, 2006; Xin & Pearce, 1996). A number of studies suggest that networking between entrepreneurs, bankers, government officials, and friends and relatives may play an important role in helping both lending institutions and corporate borrowers (Ahlstrom & Bruton; Le et al., 2006; Peng, 2001; Peng & Luo, 2000). For lending institutions, networking helps them obtain information, locate markets, and better secure their investments (Le et al.; Nguyen et al., 2006). For corporate borrowers, networks are a vehicle by which they can gain access to resources, information, and support from other parties (Hoang & Antoncic, 2003).
Thus, networking could be expected to provide to the banks information on legitimacy, which in turn should give the SMEs advantages in accessing commercial bank loans. But on the other hand, one of the greatest criticisms of banking in emerging economies is that they too often rely on networking, which results in inefficient decisions in which large amounts of loans are typically never repaid (Garcia-Herrero, Gavila, & Santabarbara, 2006; Setser, 2006). Thus, it is not clear what the net effect is of different network ties on SMEs and bank loans.
This article examines the relative effect of different network ties in helping private SMEs access bank loans. This line of research is important to academics, policy makers, and managers alike, as it contributes to the understanding of SMEs and networks, and why certain types of networks seem more important for SMEs than others in accessing bank loans. We develop a model that links different types of network ties with the use of bank loans, and report an empirical test of that model in Vietnam's emerging economy. Contemporary Vietnam represents a good context for this study, with a pronounced form of entrepreneurship that operates in the virtual absence of well-established market institutions. Different network ties are extensively exploited by both banks and SMEs, allowing us to distinguish their relative importance in accessing bank financing.
In the following section, we briefly discuss institutional theory as it relates to networks and external debt financing for SMEs in emerging economies. We then develop hypotheses on the influence of different network ties for bank financing. Next, we describe our research methodology and report the results. A discussion of the theoretical and managerial implications of these findings concludes the article.
Institutional Theory, Networks, and External Debt Financing
Institutional Theory
The central premise of institutional theory is that organizations adopt structures and practices that are "isomorphic" to established organizations or professions as a result of their quest for legitimacy. Legitimacy serves as the "anchor-point of a vastly expanded theoretical apparatus" (Suchman, 1995, p. 571). It refers to the extent that key stakeholders, the general public, key opinion leaders, and/or government officials are cognizant of, and accept, the organization and its practices (Aldrich & Fiol, 1994; DiMaggio & Powell, 1983; Meyer & Rowan, 1977; Meyer & Scott, 1983; Scott, 1995).
According to this theoretical perspective, institutional factors affect organizations' strategies and processes (Meyer & Rowan, 1977; Scott, 1995). Organizations that conform to the "rules of the game" (North, 1990) and become "isomorphic" with their environment (Meyer & Rowan) gain the legitimacy and resources needed to survive. Thus, an organization' s success depends more on its legitimacy than on efficient coordination and control of productive activities. In the lending context, institutional theory predicts that firms with stronger legitimacy should get better access to external financing.
Aldrich and Fiol (1994) distinguished cognitive legitimacy and sociopolitical legitimacy. Cognitive legitimacy refers to the extent the general public knows about the organization and its practices. When an activity becomes so familiar and well known that it is taken for granted, time and other organizing resources are conserved. The highest form of cognitive legitimacy is when an organization and its actions are so well known and accepted that it is taken for granted. Sociopolitical legitimacy refers to the extent to which a new organization conforms to recognized principles and accepted rules. It can be measured by how key stakeholders, the general public, and government officials accept the organization and its practices as "appropriate and right given existing norms and laws" (Aldrich & Fiol, p. 648).
This suggests that firms need to develop cognitive and sociopolitical legitimacy to get access to external financing. A firm that is well known to key stakeholders, that is viewed as following accepted rules and standards, and that has acceptable businesses and practices familiar to the potential fund providers should have better access to loans. Therefore, a key challenge for the firm is not only becoming "isomorphic" to the environment, but also making potential financial providers and related stakeholders aware and accepting of its practices.
Networks and External Financing
Here, we adopt the institutional view and argue that networks increase a firm's legitimacy, which in turn positively influences the firm's accessibility to external financing (Ahlstrom & Bruton, 2006). In the absence of effective market institutions, networks play an important role in spreading knowledge about a firm's existence and its practices. Networks also help a firm learn appropriate behavior and therefore obtain needed support from key stakeholders and the general public. In large part, networking substitutes for the lack of effective market institutions (Hoang & Antoncic, 2003; Peng, 2001; Redding, 1990), and can be an effective way for SMEs to access external financing, including bank loans in emerging economies.
Much of the entrepreneurship, finance, and economic literature on SME financing indicates that it is often difficult and expensive for SMEs to access bank financing, due in large part to information asymmetry between banks and firms (Ebben & Johnson, 2006; Winborg & Landstrom, 2000). Thus, it is both necessary and desirable for SMEs to find alternative sources of capital to satiate their need for capital. Various alternative sources of external debt financing may be available to SMEs, including trade credit, loans from relatives and friends, and support from governments. These alternative sources of financing appear to be critically important for SMEs in emerging economies, where more formal and extensive financial markets are typically underdeveloped (O'Connor, 2000; Smallbone & Welter, 2001), and where problems pertaining to information asymmetry and opportunism are often more pronounced (Boisot & Child, 1996). Further, these alternative sources of financing are often more accessible, convenient, and, sometimes, cheaper; government support programs provide loans with interest rates well below those offered by commercial banks. Networking, by helping SMEs access these sources, could reduce the need for bank loans. Several empirical studies support this point (Hussain, Millman, & Matlay, 2006; McMillan & Woodruff, 1999, 2002).
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