A Psychology-Enabled Solution to Small- and Medium-Sized Enterprise Finance

Industrial and Organizational Psychology has developed tools to solve a similar problem: personnel selection. Big companies need to select among a large number of individuals applying for a job. This has to be done with relatively low transaction costs, a

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A Psychology-Enabled Solution to Small- and Medium-Sized Enterprise Finance

Abstract Industrial and Organizational Psychology has developed tools to solve a similar problem: personnel selection. Big companies need to select among a large number of individuals applying for a job. This has to be done with relatively low transaction costs, and there is little information available to separate the good candidates from the bad candidates—a very similar problem to that facing the banks. Psychologists have developed psychometric tools to measure things like personality, motivation, outlook, and intelligence, which are related to subsequent job performance. These tools have been shown to work even better than other methods like interviews and background checks, and are widely used. What if they could be applied to the selection of small businesses to lend to? We review a variety of academic studies that have already used these tools to evaluate entrepreneurs and distinguish entrepreneurs from non-entrepreneurs and good entrepreneurs from bad entrepreneurs. The studies center on three main themes: personality, intelligence, and honesty. The first two relate to the ability to repay a loan, in that they could identify entrepreneurs who are more likely to successfully grow their business and its cash flows. Honesty relates to the willingness to repay a loan, as banks need to worry not just if the entrepreneur has enough money to repay but if they then decide to repay or else take the money and run. These studies provide initial insight into what particular characteristics and abilities could be systematically related to credit risk, and used for future lending to small business owners who would traditionally be rejected by banks due to a lack of information.

Industrial and organizational psychology has been working on a problem very similar to the challenge facing banks wanting to lend to small- and medium-sized enterprises in emerging markets. That problem is selection in human resources. Firms must decide which individuals to hire, based on little available information. Moreover, particularly for entry-level positions, firms must evaluate a large number of applicants in a low-cost way. To solve this problem of little information to evaluate individuals, and the inability to bear large transaction costs in that evaluation, is B. Klinger et al., Enterprising Psychometrics and Poverty Reduction, SpringerBriefs in Psychology: SpringerBriefs in Innovations in Poverty Reduction, DOI 10.1007/978-1-4614-7227-8_2, © The Authors 2013

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A Psychology-Enabled Solution to Small- and Medium-Sized Enterprise Finance

quite similar to the problem facing small- and medium-sized enterprise lenders in emerging markets. And to help solve this problem, industrial and organizational psychologists have developed a very large toolkit of tests. And it turns out that many of these tests have already been used to study the characteristics of successful entrepreneurs, finding a variety of robust relationships. These tools and results will b