Determinants of the Rehabilitation of Defaulting Small Businesses: Are real or financial factors important?

We investigate the differences in firm performance between non-defaulting firms and firms that have defaulted on their bank loan, and factors that determine these differences, using small business data. Many previous studies investigate the determinants of loan payment defaults by small businesses. However, few papers investigate small business activities and performance after they default. Using firm-level data from Japan, we show that bank borrowings, return on assets (ROA), and sales growth are all lower after such defaults. These negative effects last approximately 10 years after default if the firm survives, suggesting that the constraints associated with a default have negative effects on firm performance for extended periods. In addition, firms with weak financial statements before the default are unlikely to survive, but those that survive enjoy a high ROA. Next, asset growth, ROA, sales growth, younger management, and the existence of a successor have positive effects on firm survival after a default. These imply that real factors are important for firm survival after a default. Lastly, additional credit and reduction of interest payments have positive effects on sales growth after a default, but negative effects on ROA. This suggests that financial support from banks has a limited effect on the survival of defaulting small businesses.