First Draft: Jan 2003. This Draft: November 2004
Barriers to Entrepreneurship
Leora Klapper, Luc Laeven, and Raghuram Rajan*
Using a comprehensive database of firms in Western and Eastern Europe, we study how the
business environment in a country drives the creation of new firms. Our focus is on regulations
governing firm creation (“entry regulations”) and on financial development. We find entry
regulations hamper the creation of new firms, especially in industries that naturally should have
high entry. Also, value added per employee in naturally “high entry” industries grows more
slowly in countries with onerous regulations on entry. The consequences of regulatory barriers
against entrepreneurship are seen, not in young firms, but in older firms, who grow more slowly
and to a smaller size. Thus the absence of the disciplining effect of competition from new firms
has real adverse effects. Interestingly, regulatory entry barriers have no adverse effect on
entrepreneurship in corrupt countries, only in less corrupt ones. Taken together, the evidence
suggests bureaucratic entry regulations, when effectively implemented, are neither benign nor
welfare improving. Turning to financial development, we find that both the availability of private
(bank) credit and of trade credit does aid entry in financially dependent industries. Thus unlike
entry regulations, regulations that improve access to finance can aid entrepreneurship.
* Klapper is at the World Bank, Laeven is at the World Bank and CEPR, and Rajan is at the IMF and
NBER. We thank Allen Berger, Arnoud Boot, Stijn Claessens, Mihir Desai, Simeon Djankov, Alexander
Dyck, Stephen Haber, Robert Hauswald, Simon Johnson, Steven Kaplan, Naomi Lamoreaux, Inessa Love,
Vojislav Maksimovic, Atif Mian, Michel Robe, Roberta Romano, Jean-Laurent Rosenthal, Gregory Udell,
Christopher Woodruff, and seminar participants at the Fifth International Conference on Financial Market
Development in Emerging and Transition Economies in Hyderabad, American University, University of
Amsterdam, University of Maryland, the NBER Corporate Finance Program Meeting at the University of
Chicago, and the SME Conference at the World Bank for valuable comments, Ying Lin and Victor Sulla
for outstanding research assistance, Sebastian Roels at Bureau Van Dijk for help with the Amadeus data,
and Brian Williams and Ryan Paul at Dun & Bradstreet for help with the Dun & Bradstreet data. Rajan
thanks the National Science Foundation, the Center for the Study of the State and the Economy at the
Graduate School of Business, University of Chicago for research support during part of this study. We also
thank the World Bank for financial support. An earlier version of this paper circulated under the title
“Business Environment and Firm Entry: Evidence from International Data”. This paper’s findings,
interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views
of the World Bank, the IMF, their Executive Directors, or the countries they represent.
Entrepreneurship is a critical part of the process of creative destruction that Joseph
Schumpeter (1911) argued is so important for the continued dynamism of the modern economy.
That it affects economic growth has been documented in previous work. 1 However, much less is
known about the business environments that promote new firm creation. This is an important
concern for policymakers, who in country after country are trying to implement policies that will
foster entry – witness, for example, the debate in Continental Europe on the lack of home-grown
venture capital in promoting new firm creation in high tech industries.2
A first step is to understand what the cross-country picture really looks like. We use a
comprehensive, recently available database of firms across a number of developed and transition
countries in Europe to address this question. Some facts are striking. For instance, one might
believe that Italy, with its myriad small firms, should have tremendous new firm creation (we use
“new firm creation”, “entry”, and “entrepreneurship” interchangeably). Actually, new firm
creation in Italy (the number of firms less than two years of age to the total number of firms) is
only 3.8 percent compared to 13.5 percent on average for other European countries in the G-7.
Two important aspects of the business environment are regulations and access to
resources, especially finance. Let us start with regulations, especially bureaucratic regulations on
setting up limited liability companies, in explaining varia tions in patterns of entrepreneurship.
The early debate on such corporations emphasized the possibility that crooks might register with
little capital and dupe unsuspecting investors or consumers. For instance, the Times of London
thundered against the principle of free incorporation through limited liability thus in 1824:
“Nothing can be so unjust as for a few persons abounding in wealth to offer a portion of their
excess for the information of a company, to play with that excess for the information of a
company – to lend the importance of their whole name and credit to the society, and then should
1 For example, Hause and Du Rietz (1984), Asplund and Nocke (2003), Black and Strahan (2002).
2 “Europeans Now Seek to Revive Start-Up Spirit”, Wall Street Journal, February 6, 2002.
the funds prove insufficient to answer all demands, to retire into the security of their unhazarded
fortune, and leave the bait to devoured by the poor deceived fish.” 3
According to this view, entry regulations serve the public interest by preventing fraud.
By contrast, a long literature describes regulations as devices to protect the private
interests of industry incumbents (see Smith 1776, Olsen 1965, or Stigler 1971) or the regulators
(Bhagwati 1979, Krueger 1974, McChesney 1997, Shleifer and Vishny 1998). For example,
Smith (1776) 4:
“To widen the market and to narrow the competition is always the interest of the dealers…The
proposal of any new law or regulation of commerce which comes from this order, ought always
to be listened to with great precaution, and ought never to be adopted, till after having been long
and carefully examined, not only with the most scrupulous, but with the most suspicious
attention. It comes from an order of men, whose interest is never exactly the same with that of the
public, who generally have an interest to deceive and even oppress the public, and who
accordingly have, upon many occasions, both deceived and oppressed it.”
The evidence in Djankov et al. (2002) that countries with heavier regulation of entry have
higher corruption and larger unofficial economies certainly is consistent with the private interest
view of regulation. But it does not rule out other possibilities – for instance, regulations could be
less burdensome in corrupt countries because officials can be bribed to ignore them (we do find
evidence for this) so there is no strong demand to streamline them, or regulations may be
promulgated in corrupt countries precisely because it is more important for an even more
untrustworthy corrupt private sector to be screened. At present, the case against such regulations
is primarily based on aggregate impressions modulated by theory rather than by actual detailed
evidence on their microeconomic consequences.
This suggests a number of steps. First, one has to show that these regulations do affect
entrepreneurship. One cannot, however, ascertain this simply from a cross-country regression of
actual firm creation against the size of regulations. If the coefficient estimate on regulations is
3 As quoted in Paul Halpern, Michael Trebilcock and Stuart Turnbull, 1980, “An Economic Analysis of
Limited Liability in Corporate Law”, University of Toronto Law Review 117: 30.
4 Adam Smith 1776 ed. Edwin Cannan 1976. The Wealth of Nations Chicago: University of Chicago Press,
Book 1, Chapter XI, p. 278.
negative, the skeptic could argue that causality could go the other way – that in countries with
generally low entrepreneurship, people are not sufficiently motivated to press for the repeal of
archaic regulations that impede entry. Thus even though the regulations themselves may have no
direct effect on entrepreneurship, there could be a negative correlation between regulatory
restrictions and entrepreneurship.
To address this sort of problem, we focus on cross-industry, cross-country interaction
effects (that is, we ask if entry is more likely in an industry with a particular need when the
country scores strongly on a characteristic that facilitates meeting the need) rather than on direct
industry or country effects. In particular, if we can somehow proxy for the “natural” rate of entry
in an industry, we test whether entry is relatively lower in “naturally high entry” industries when
they are in countries with high bureaucratic restrictions on entry.
This methodology, following Rajan and Zingales (1998), enables us to address a number
of other issues as well – for instance the problem that a healthy economy scores well on a number
of cross-country variables, so it is hard to estimate the direct effect of each variable in a cross-
country regression (and equally hard to correct for all possible country variables that might
matter). By focusing on interactions, we can absorb country level variables and instead examine
the differential effects of country level variables across industries that might respond most to
them. Also, some industries may be technologically more predisposed to entry. By correcting for
industry effects, we also correct for the fact that average entry rates depend on the industries
present in a country.
The downside of this methodology is, of course, that while it can tell us whether the
country characteristics work in predicted economic ways, it cannot tell us the overall magnitude
of the effect of the characteristics, only the relative magnitude.5 But since our primary interest is
5 Of course, we could revert to cross-country regressions for that, but we cannot tell how much of the
estimated effect is likely to be because of causal relationships and how much is simple correlation. See,
however, Desai, Gompers, and Lerner (2003).
to examine the validity of theories that suggest bureaucratic entry regulations should affect entry,
this is not a major concern.
Turning to results, we find that “naturally high-entry” industries have relatively lower
entry in countries that have more onerous bureaucratic entry regulations. This also suggests an
explanation for the low level of entry in Italy: the average direct cost associated with fulfilling the
bureaucratic regulations for setting up a new business in Italy is 20 percent of per capita GNP
compared to 10 percent of per capita GNP on average for other G-7 European countries.
It may be that countries with large “high natural entry” industries and a strong
entrepreneurial culture choose to have low entry regulation. To address this potential
problem, we check whether the result holds when we restrict the sample to industries that
are relatively small. These industries are unlikely to be responsible for the entry barriers
since they have limited political clout. We still get a strongly significant interaction
coefficient. This suggests that industries that are unlikely to be responsible for the entry
regulations are equally affected by it.
Finally, it may be that countries with untrustworthy populations erect higher bureaucratic
barriers so as to screen their fellowmen (though why the bureaucrats should be deemed more
trustworthy is a relevant question). If this were true, bureaucratic barriers might affect entry, and
might cause incumbents to become fat and lazy, but this is necessary because the alternative of
unrestricted entry by charlatans would be much worse. This is a harder proposition to refute but
our analysis offers some evidence that is inconsistent with it. More developed countries have
better developed information systems, better product inspections and quality control, better
contract and law enforcement, and consequently, an entrepreneurial population less subject to
misbehavior.6 If bureaucratic rules were meant to screen entry efficiently, we should expect them
6 The underlying population in richer countries may also be socialized to be more honest (fewer rogues) but
all that is relevant is that the richer infrastructure gives them more incentive to behave, so there is less need
to be particularly effective in low-income countries relative to high-income countries. Similarly,
we should find them particularly effective in corrupt countries.
It turns out that entry barriers are more effective in preventing firm creation in high
income countries, suggesting their purpose is not to screen out the untrustworthy (or that low
income countries have other natural barriers that prevent firm creation). More interesting, entry
barriers are effective in retarding entry only in the least corrupt countries. On the one hand, this
suggests that bureaucratic entry barriers in corrupt countries may be ineffective roadblocks,
meant solely for extracting bribes (see, for example, Shleifer and Vishny (1997) and Djankov et
al. (2002)). However, their existence and effectiveness in less blatantly corrupt countries suggests
that their purpose may well be to protect incumbents and their rents (see, for example, Acemoglu
(2003), Perotti and Volpin (2003), and Rajan and Zingales (2003a)).
All this does indicate that these bureaucratic regulations on entry work as intended but it
does not help us distinguish between the views that these entry barriers are socially harmful and
that they are socially beneficial. If these entry barriers screen appropriately as in the view that
they are framed in the public interest, we should find that incumbent older firms in naturally high
entry industries should grow relatively faster (than similar firms in similar industries in countries
with low entry barriers) because efficient ex ante bureaucratic screening takes the place of
growth-retarding wasteful competitive destruction.
By contrast, the private interest view would be more ambiguous in its predictions. By
setting up protectionist entry barriers, incumbent firms might ensure themselves more growth, but
the lack of competition may make them inefficient. A finding that incumbent firms in naturally
high-entry industries grow relatively less fast in high entry barrier countries would be consistent
with the private interest view rather than the public interest view.
The evidence is more consistent with the view that entry regulations are framed with
private interests in mind rather than for the public interest. Growth in value added is relatively
lower in naturally high entry industries when the industry is in a country with higher bureaucratic
barriers to entry.
The details of this result are particularly suggestive. The slower growth could be
attributed to incumbents having more monopoly power and restricting quantities, or to them being
less efficient as they are less subject to the discipline of competition. One piece of evidence
suggests the latter explanation. Older firms in naturally high entry industries grow relatively more
slowly in countries with high bureaucratic barriers while the relative growth of young firms is
indistinguishable. Since age should not affect the incentive to restrict quantities, this is consistent
with older firms, who have had to survive greater competition in countries with low entry
barriers, becoming relatively more efficient and continuing to grow.
In this regard, the comparison between high-bureaucratic -entry-barrier Italy and low-
entry-barrier United Kingdom is particularly telling. Across all industries, firms start out larger
when young in Italy, but grow more slowly so that firms in the United Kingdom are about twice
as large by age ten. This suggests Italy has small firms not because there is too much entry but
perhaps because there is too little !
Turning to the effects of financial development, we would expect that new firms would
be particularly benefited by access to finance in industries that require a lot of external financing.
We do find that entry is relatively higher in industries that depend heavily on external finance in
countries with greater financial development. What is particularly interesting is that we find entry
is relatively higher in industries that depend on trade credit financing in countries with greater
extension of trade credit, even after controlling for the traditional effects of financial
development. This suggests that supplier credit is an important aid to entrepreneurship.
For completeness, we also examine the effects of regulations that protect intellectual
property, labor regulations, and the effects of education and taxes. Entry is higher in R&D
intensive industries in countries with better protection of intellectual property, and higher taxes on
corporate income relative to personal income tends to reduce new entry in high entry industries
(that is, higher taxes work much as regulatory barriers). Labor regulations do not, however, have
significant effects. Taken together, our results suggest that while bureaucratic entry requirements
seem to be motivated by private interests, it is by no means obvious that the best way to
encourage entry and competition is to eliminate all regulation. The absence of some regulations
can also be an effective entry barrier (see Rajan and Zingales (2003, a, b)). Regulations that
expand access to finance and strengthen property rights seem to help entry even while those that
directly screen entrants hurt entry.
In a related paper, Desai, Gompers, and Lerner (2003) use a cross-country approach and
also find that entry regulations have a negative impact on firm entry. The cross-country approach
has a number of limitations. In particular, variations in coverage in the database across countries
could affect findings, a problem that a within country, cross industry approach is more immune
to. Nevertheless, their findings are complementary to ours. Another related cross-country study is
Scarpetta et al. (2002), who use firm-level survey data from OECD countries to analyze firm
entry and exit. They find that higher product market and labor regulations are negatively
correlated with the entry of small- and medium-sized firms in OECD countries. Bertrand and
Kamarz (2002) examine the expansion decisions of French retailers following new zoning
regulations introduced in France. They find a strong relation between increases in entry
deterrence (such as rejection of expansion or entry decisions) and decreases in employment
Others have found that financial development seems to foster entry (see Black and
Strahan (2002) or Rajan and Zingales (1998)). Di Patti and Dell’Ariccia (2004) examine whether
entry is higher in informationally opaque industries in Italian regions that have a more
concentrated banking sector (they find it is). Their use of the Rajan and Zingales methodology is
similar to ours, but the environmental variables they focus on, as well as the data they use, are
very different. Finally, Fisman and Love (2003a) find that industries with higher dependence on
trade credit financing exhibit higher growth rates in countries with relatively weak financial
There is also work related to other aspects of our study than entry regulation or financial
development. Kumar, Rajan and Zingales (2000) find that the average size of firms in human
capital intensive industries (and in R&D intensive industries) is larger in countries that protect
property rights (patents). Using survey data from five transition countries on the reinvestment of
profits by entrepreneurs, Johnson et. al. (2002) examine the importance of property rights. They
find lower investment by entrepreneurs in countries with weak property rights. Claessens and
Laeven (2003) find that growth of industries that rely on intangible assets is disproportionately
lower in countries with weak intellectual property rights. Our finding that there is less entry in
R&D intensive industries when property is weakly enforced echoes their findings.
There is a substantial literature on entry into an industry (possibly by a firm from another
industry) as distinguished from firm creation or entrepreneurship. It is the latter sense in which
we use the term “entry”. It would take us too much out of our way to describe the literature on
industry entry, so we refer the reader to Gilbert (1989) for a comprehensive survey. Note that
there are technological determinants of entry into an industry such as minimum scale, etc., which
also affect firm creation. We assume these determinants carry over countries so they are absorbed
by industry indicators. Our focus then is on environmental determinants of firm creation.
The paper proceeds as follows. In Section I we describe the data and in Section II we
present the empirical methodology. We present the empirical results in Section III. We conclude
in Section IV.
1.1 Amadeus Database
Central to our analysis is the firm-level Amadeus database. Amadeus is a commercial
database provided by Bureau van Dijk. It contains financial information on over 5 million private
and publicly owned firms across 34 Western and Eastern European countries. The database
includes up to 10 years of information per company, although coverage varies by country.
Amadeus is especially useful because it covers a large fraction of new and small- and medium-
sized companies (SMEs) across all industries. The Amadeus database is created by collecting
standardized data received from 50 vendors across Europe. The local source for this data is
generally the office of the Registrar of Companies.
The Amadeus database includes firm-level accounting data in standardized financial
format for 22 balance sheet items, 22 income statement items and 21 financial ratios. The
accounts are transformed into a universal format to enhance comparison across countries, though
coverage of these items varies across countries. We use IMF-IFS period average exchange rates
to convert all accounting data into U.S. dollars.
In addition to financial information, Amadeus also provides other firm-level information.
We use information on the year of incorporation to calculate the age of the firm. Amadeus also
assigns companies a 3-digit NACE code – the European standard of industry classification –
which we use to classify firms and construct industry dummy variables.7 In our analysis, we use
NACE codes at a 2-digit level so that we have a sufficient number of firms per industry.
1.2 Sample Selection
We use the 2001 edition of Amadeus and limit our sample to the years 1998 and 1999.8
There are two reasons to limit our analysis thus. First, there is the potential problem of
survivorship: As companies exit or stop reporting their financial statements, Amadeus puts a "not
available/missing" for 4 years following the last included filing. Firms are not removed from the
database unless there is no reporting for at least 5 years (i.e. 1997 or earlier). So the data for firms
from 1997 as reported in the 2001 database will not include firms that exited in 1997 or before.
To avoid this potential survivorship bias, we restrict our attention to 1998 and 1999. A second
7 The NACE codes follow the NACE Revision 1 classification.
8 Due to lags in data collection, the coverage for the year 2000 is incomplete.