On This Page1997, No. 1997-22

A Trojan Horse or the Golden Fleece? Small Business Investment Companies and Government Guarantees
Last Updated: 10/23/97

Profitability is a central concern when governments provide guarantees to increase the flow of funds to disadvantaged groups. The authors examine the profitability of small business investment companies (SBICs) that are chartered and regulated by the U.S. Small Business Administration (SBA) to finance the activities of small firms. They document, over the 1986-91 period, dismal performance by SBICs. Because SBICs have access to government-guaranteed funds, financial distress among SBICs can expose the SBA, and hence taxpayers, to losses. Using two alternative sample selection models, they examine the relationship between SBICs’ use of SBA funds and returns on equity (ROE) and survival probabilities. The first sample selection model is based on a model of failure/survival. The second selection model is based on their observation that many SBICs do not take advantage of SBA leverage: nearly one-third of SBICs use no leverage at all, and that figure rises to three-fifths for bank-owned SBICs. The results from their sample selection models indicate that SBA leverage--the amount of funds borrowed from the SBA as a percent of private capital--reduces ROE and the probability of survival. In addition, they find that the probability of using SBA leverage decreases for bank-owned SBICs relative to other SBICs and for highly profitable and efficient SBICs, while it increases for SBICs using debt to finance the activities of small firms. Thus, their results suggest that an SBIC’s performance is negatively correlated with SBA leverage.