Author(s): Hyunsung D Kang
This study explores the moderating effect of banks on the relationship between a start-up’s patent performance and loan default rate. By building a strong relationship with a start-up, banks may want to access the start-up’s private information, better evaluate the future value of the start-up’s technological capability and avoid adverse selections that are common in the entrepreneurial credit market. Using a dataset on 2254 Small Business Administration 7(a) loan activities involved with genetic engineering and information technology based start-ups, this study finds that start-ups that have strong patent performances tend to experience a lower rate of default. This negative relationship between a start-up’s patent performance and default rate becomes salient when banks are close to the start-ups and are of considerable size. These findings fill the gap in the literature by elaborating how banks use these distance and size effects to avoid potential adverse selections in the entrepreneurial credit market.