How Debt Creates Pressure to Perform When Information Asymmetries are Large : Empirical Evidence from Business Start-Ups

In this paper, we empirically examine how leverage affects firm performance when information asymmetries are large. We argue that entrepreneurs are strongly incentivized to maximize earnings when leverage is high in order to reduce the likelihood of adverse credit decisions and firm liquidation. Our empirical tests focus on the effects of leverage on firm profitability and growth in earnings during a 5-year window after start-up for a large and unique sample of newly established ventures in Belgium. Accounting for the endogeneity of leverage, the data reveal that more highly indebted business start-ups are not only more profitable but also realize larger earnings growth. Moreover, the positive effect of leverage on firm profitability intensifies as the venture matures