Small Business Investment: The Importance of Financing Strategies and Social Networks

Bach NGUYEN
[email protected]
Economics, Finance and Entrepreneurship Department
Aston Business School
Aston University
Birmingham, UK, B47ET

Abstract: This study examines the association between financing strategies and firm investments.
Employing theory of financing constraints and literature on formal/informal financing of small
businesses to investigate a set of 15,851 observations of Vietnamese small businesses in 11 years,
we suggest a pecking order of financing strategies in terms of firm investments, in ascending order
as follows: (1) firms using no external finance, (2) firms using informal finance only, (3) firms using
both formal and informal finance, (4) firms using formal finance only. In addition, we incorporate
the theory of social capital to explore the moderating effect of networking on the relationship
between financing and investment. Empirical results show that networks may enhance the
relationship between informal finance and firm investments, but not formal finance.

Keywords: Small business; Investment; Financing source; Informal finance; Social capital

1. Introduction

Investment is important to small businesses. Firms that make investments may or may not grow.
However, firms that make no investment achieve no sustainable growth and may even find it
difficult to maintain their survival in such highly turbulent and competitive markets (Gupta et al.,
2018). To finance investment projects, a firm basically has two financing options, i.e., internal and
external. Only when internal funds are insufficient, firms start seeking external debts to secure their
investment opportunities (Myers, 1984). However, formal external finance (e.g., bank loans) is not
always accessible, especially to small businesses in less developed economies because of issues
related to market failures.1 As such, informal finance, defined as small, unsecured and
short-in-maturity funding capital in this study, appears to be an important alternative (but less

1
Market failures include moral hazard and adverse selection, which is caused by agency costs. Moral hazard
arises when actions taken by entrepreneurs is unobservable by outside investors but bring about benefits to
entrepreneurs at the cost of investors. Adverse selection arises when entrepreneurs have more information
than investors, making it is difficult for investors to distinguish “good” projects from “bad” projects
(Hechavarria et al., 2016).

1
desired) financing source. Hoff and Stiglitz (1990) argue that the existence of informal loans is
driven by imperfections in the formal credit markets: banks ration borrowers, and the informal
sector serves those borrowers who are rationed out by banks.

These arguments from the literature lends support to four mutually exclusive financing strategies
available to small businesses, namely (1) using no external finance; (2) using informal finance only;
(3) using formal finance only; and (4) using both formal and informal finance. In this study, we
strive to explain the links between these four financing strategies and firm investment decisions. To
be specific, the first research question to be examined is that: how do dissimilar financing strategies
determine the values of investment in the context of small businesses?

It is important to understand the relationship between financing sources and firm investments
because the recent literature has pointed out some counter-findings to the conventional pecking
order theories of internal-external and formal-informal finance. For example, Nguyen (2019) argues
that external finance may be more preferred to internal finance in insecure institutional
environments with high risks of appropriation and corruption. In such a situation, entrepreneurs
are inclined to direct their businesses’ internally generated funds to safer investment channels (e.g.,
savings), and rely largely on borrowing to invest. Meanwhile, Guariglia et al. (2011) suggest that
small business in China, thanks to their high productivity, their cash flow is so abundant that they
are able to grow at a very fast rate, despite being discriminated against by local biased financial
institutions. Hence, well-developed external capital markets may not always be needed for fast
economic growth. In addition, Wu et al. (2016) suggest that informal debt can be attractive to
entrepreneurs because of its speed, subtle initial transaction fees, and freedom from collateral
requirements. As such, some firms may decide to finance their investments entirely by informal
finance or by a combination of formal and informal finance instead of switching completely to
formal finance even when they are eligible to do so.

These arguments evidently show the need to re-examine the relationship between firm financing
strategies and firm investments. In addressing this issue, we notice that social capital, defined as the
number of active contacts with business people, banking officials, and local politicians, plays an
essential role (Du et al., 2015; Tran & Santarelli, 2014; Zhou, 2013). The reason is that
underdeveloped and incomplete institutional environments in less developed countries force
entrepreneurs to strategically build and maintain an active social network to gain access to
resources required to secure their investments. Social networks exert a direct, non-financial effect
on firm investments (e.g., providing additional information, business opportunities, and

2
collaboration opportunities) (Ko & Liu, 2017; Shu et al., 2018), and an indirect effect by moderating
the relationship between financing and firm investments. While the direct effect of social capital is
relatively well-understood, its indirect effect is less clear (Heikkila et al., 2016), especially when
examining its moderating effects on the relationship of a set of financing strategies and firm
investments. As such, the second research question in this study is that: how does social capital
influence firm investments by moderating the use of formal/informal finance?

We investigate the proposed research questions in the context of Vietnam, an ideal context for the
following reasons. First, as a post-communist economy, Vietnam government still controls most of
the key strategic resources, including financial markets and land use rights (Nguyen et al., 2018).
Also, the institutional arrangements, including the financial systems of the country remain biased
heavily toward the state sector (Nguyen & van Dijk, 2012). As a result, entrepreneurs must dedicate
to relationship building (social networking) to seek external financing for their ventures in such an
environment. Second, Vietnam is an emerging economy characterised by the booming of the
entrepreneurial sector (young and small private businesses). They are the key driver of the
phenomenal economic transformation of the nation in the last decade (Santarelli & Tran, 2016).
Therefore, it is essential to understand how they finance their investments in such an adverse
institutional environment and the role of social networks in their financing strategies. Although a
within-country research setting clearly sets a boundary condition to our findings, such a context of
Vietnam allows us to identify the significance of financing strategies and social networking to the
investment decisions of entrepreneurial firms, thereby making relevant implications.

We take advantage of the unique information in the Small and Medium Enterprise (SME) dataset
conducted by the Central Institute for Economic Management (CIEM) of Vietnam. Specifically, we
analyse more than 15 thousand observations of small businesses in the period 2006-2018 to see
how firm investment varies with different financing strategies as well as the role played by social
networking in firm financing. To ensure the robustness of the findings, besides the conventional
fixed-effects (FE) method, we also use bias-adjusted treatment effects technique and general
method of moment (GMM) technique to reduce concerns with potential endogeneity-related issues
in the empirical estimation.

Findings in this study propose a pecking order of firm financing strategies in terms of investment.
Specifically, the pecking order in ascending investment values is as follows: (1) firms using no
external finance, (2) firms using informal finance only, (3) firms using both formal and informal
finance, and (4) firms using formal finance only. We also find that social networks are able to

3
enhance access to informal loans and boost firm investment subsequently. However, we observe no
evidence showing that social networks, even networking with bank officials, improve access to
formal debts. Finally, in a robustness test, we find that social networks are more relevant to
registered firm investment than to household business investment.

2. Literature and Hypotheses

2.1. Financing sources and firm investments

While the link between financing sources and firm performance has recently attracted some
research interest (Ayyagari et al., 2010; Beck et al., 2015; Du & Girma, 2012), the theoretical
foundation that connects these two concepts is not clear and relatively hard to establish. The reason
is that there are numerous mechanisms that play simultaneously. For example, one mechanism
could be that each financing source is associated with different levels of monitoring and contract
enforcement, creating dissimilar degrees of entrepreneurial commitment and inputs, hence
influencing productivity and efficiency, and firm performance ultimately. Another mechanism,
which is discussed in this paper, is the effects of alternative financing sources on the values of firm
investment that subsequently also influence firm performance.

Our objective is to compare the investments of firms employing different sets of financing sources.
The first pair of comparison is firms that use no external finance and firms that use informal
finance. However, difficulty in comparing the investments of these two types of firms is that firms
that use no external finance could be a sum of financially constrained firms and cash-abundant
firms.2 The former indicates firms whose internally generated funds are insufficient to support their
investments, and that they need external finance but fail to secure funding. The latter are companies
whose internal funds are sufficient to support their investments and that they have no need to seek
external finance.

If the number of cash-abundant firms dominates the population of firms using no external finance,
it is arguably reasonable to expect that the group of firms using no external finance are less
financially constrained than the group of firms that need to seek informal finance. As a consequence,
firms using no external finance are more likely to make a higher investment than firms using
informal finance, on average. However, extant research suggests that this scenario is less likely the
representative in reality, especially in developing countries. In fact, the opposite hypothesis obtains
more support from the literature that firms (which have no access to external finance as such) use

2
Carreira and Silva (2010) define financing constraints as the inability of a firm to raise the necessary capital
to finance its optimal path of growth.

4
no external finance are more financially constrained than firms having access to informal loans
(Lebiere & Anderson, 2011; Nguyen, 2019). Also, Carreira and Silva (2010) document some stylised
empirical results on firms' financing constraints. One salient fact is that most young and small
businesses are likely financially constrained because they have yet established sufficiently strong
and trackable performance records, which raise significant informational asymmetry concerns for
external lenders. For this reason, small firms that use no informal finance are likely to be financially
constrained rather than to be cash-abundant.

In addition, small private businesses in less developed countries also encounter substantial
institutional biases, which cause severe financial resource constraints (Allen et al., 2005). For
example, in Vietnam, Van Thang and Freeman (2009) evidently show that the greater the density of
state-owned firms present in a region, the more they enjoy favouritism, the lower is the proportion
of bank loans that go to private companies, and the longer it takes for private firms to get access to
land. While large companies can easily establish connections with local authorities/moneylenders
to secure financial resources, small businesses can hardly join into this circle because they cannot
afford transactions that are big enough to attract politicians/bank officials (Du & Mickiewicz, 2016).
For this reason, only a fraction of small firms successfully obtains external loans (Heikkila et al.,
2016); and the majority of them are likely to function in sub-optimal financing conditions (Kislat,
2015). For example, in the context of Vietnam, Rand (2007) using direct information from a
Vietnamese enterprise survey shows that between 14% and 25% of the enterprises suffer from
extreme credit constrained, and these enterprises would increase their debt holdings by between
40% and 115% if borrowing constraints were relaxed.

Moreover, Hayes and Allinson (1994) suggest that firms that use no external finance may suffer not
only from financing constraints but also from cognitive financial constraints – a situation in which a
firm does not obtain sufficient external funds to support its operations primarily because of
entrepreneur’s cognitive style (Lebiere & Anderson, 2011; Tyson, 2008). Specifically, it describes
the state of mind of many entrepreneurs running small businesses that constrains them from
requesting financial access; not because the funds are unnecessary or inaccessible, but rather
because of their cognitive constraints. This type of entrepreneurship is found popular in both
developed and developing countries, and they will not actively seek out external loans even if the
financial constraint problems are mitigated (Fraser et al., 2015). Specifically, in the context of
Vietnam, Nguyen and Canh (2020), analysing a sample of 2,500 Vietnamese SMEs from 2005 to
2015 evidently show that individuals with cognitive financial constraints originating from their
background characteristics (i.e. minor ethnicities, females) are less likely to use external finance.

5
In general, evidence from the literature seems to suggest that small businesses that use no external
finance may not obtain sufficient capital to fund their investment projects. Meanwhile, firms that
successfully gain access to external loans, including loans from informal sources, may have
overcome the cognitive constraints and have a larger room of finance to fund their desired
investment projects. As such, we propose the following hypothesis:

Hypothesis H1a: The investment values of firms gaining access to informal finance are higher
than the investment values of firms having no access to external finance.

The second pair of comparison is firms that use informal finance and firms that use formal finance.
Informal finance is of significant advantages like speedy and simple procedures, subtle initial
transaction fees, and freedom from collateral requirements (Wu et al., 2016). However, informal
finance is small, unsecured and short-in-maturity funding capital, which may not satisfy firms with
long-term and/or large-scale investment projects. Meanwhile, formal finance is the financing capital
sourced from banks and other formal financial intermediaries. The key distinguishing characteristic
between the two is that formal finance lending is processed based on hard information and
arm-length principles while the decision of lending informal finance is processed using soft
(private) information and relationship-based principles (Ayyagari et al., 2010; Nguyen, 2019).

Given this difference between the two, entrepreneurs face trade-offs in deciding the appropriate
source of financing for their businesses. To maximise benefits from borrowing, small firms are keen
to match investment projects to appropriate financing sources (O'Toole et al., 2016). To be specific,
informal loans are more preferred for urgent, short-term, and small-scale projects (e.g. to make up
temporarily insufficient working capital) (Tsai, 2004). Meanwhile, formal (bank) loans, due to their
lower interest rate associated with higher application costs, are more suitable to finance
well-planned, long-term, and large-scale investment projects (e.g., fixed assets investments)
(Ayyagari et al., 2010). Empirically, Barslund and Tarp (2008), examining a set of 932 rural
household businesses in Vietnam, disclose that formal loans are almost employed for production
and asset accumulation, while informal loans are used for consumption smoothening. Also, from the
viewpoint of the specialisation of the financial markets, Bao Duong and Izumida (2002) reveal that
in Vietnam, the formal sector specializes in lending for production purposes whereas the informal
sector's lending is quite diverse but mostly associated with lower valued spending. Therefore, it is
expected that the values of investment projects funded by formal debts are typically larger than the
values of investment projects funded by informal loans only. Put it formally, we have:

6
Hypothesis H1b: The investment values of firms gaining access to formal finance are higher
than the investment values of firms using informal finance only.

The next pair of comparison is firms that use formal finance and firms that use both formal and
informal finance. To make such a comparison, we first need to clarify the relationship between
formal and informal finance.

In fact, the extant literature offers different views on the relationship between the two sources. One
view is that informal finance serves as the last resort for entrepreneurs that are quantity-rationed in
the more desirable formal sector. This rationing may arise because formal lenders have limited
information and thus rely on collaterals to overcome moral hazard and adverse selection intrinsic in
credit transactions (Jain, 1999; Menkhoff et al., 2012). Firms that fail to provide sufficient collaterals
are automatically screened out and are forced to find informal lenders, who are due to their
informational advantages, can substitute information-intensive screening and monitoring for
collaterals (Guirkinger, 2008). The informational advantages of the informal sector (private
moneylenders in particular) substantially reduce transaction costs which may drive the effective
cost of informal loans below the effective cost of formal loans. However, the price (i.e., the interest
rate) offered for the borrowers in the informal sector (private moneylenders in this case) is typically
much higher than the price in the formal sector. Floro and Ray (1997) explain this phenomenon
citing that the informal sector is regional monopolistic or informal lenders are likely to engage in
strategic cooperation, thus limiting competition.

In contrast to the ‘last resort’ view of informal finance, there is another view that the informal
sector may also be preferred to the formal sector. Scholars supporting this view typically cite
funding from family, friends, and relatives as their research subjects. In the initial stage of the
venturing or in urgent situations, these informal funding may act as seeding capital or speedy
capital that satisfy entrepreneurs’ need of capital with low costs and flexible repayment schedules
(Elston et al., 2016). In terms of private moneylenders, Boucher and Guirkinger (2007) argue that
they have greater access to private information, enabling them to write contracts that are more
state-contingent than formal contracts and thus are less risky for borrowers. As such, entrepreneurs
that unwilling to assume the risk of a formal contract are inclined to seek informal finance.

Given these complementary/substitute viewpoints on the relationship between formal and informal
finance, we suggest two possibilities. The first is that firms using formal finance invest more than
firms using both formal and informal sources. This scenario is more likely when entrepreneurs
consider formal finance is the most desired capital, and that they need to seek informal loans

7
because a proportion of their formal applications is rationed out (Nguyen, 2019). On the contrary,
another possibility is that firms using both sources of finance invest more than firms using formal
finance only. This scenario is more likely when entrepreneurs consider informal loans are an
additional financing option to boost their (different sized) investment projects instead of relying
completely on formal loans (Guirkinger, 2008). Based on this scenario, we propose the following
hypothesis:

Hypothesis H1c: The investment values of firms using both formal and informal finance are
higher than the investment values of firms using formal finance only.

It is noteworthy that the opposite expectation that firms using formal finance invest more than
firms using both formal and informal finance will also be tested. Since the extant literature remains
mixed and fragmented, and there is no dominant theory that leads to a clear expectation from the
two scenarios, we thus stay open to explore the investment values of these two types of firms.

If hypotheses H1a, H1b, and H1c are supported, we are able to propose a pecking order of financing
strategies in terms of firm investments. Specifically, the pecking order in ascending investment
values is as follows: (1) firms using no external finance, (2) firms using informal finance only, (3)
firms using formal finance only, and (4) firms using both formal and informal finance.

2.2. Social capital and firm investment

‘Social capital is defined as the structure of informal social relationships conducive to

developing cooperation among economic actors aimed at increasing social product,
which is expected to accrue to the group of people embedded in those social
relationships.’ (Hayami, 2009, p. 98)

This definition of social capital implies the role of social relationships forged through informal
organisations, which could be horizontal (e.g., sports clubs) or hierarchical (e.g., family members).
These relations are informal in the sense that they are not enforced by the state’s coercive power.
And by social product, the idea is to indicate the total value added from the use of social capital. One
of the key distinctions between human capital and social capital is that the former is owned and
used individually, whereas the latter is owned and used jointly (Santarelli & Tran, 2013). As such,
the faithful fulfilment of the agreed-upon obligation (i.e., trust) is considered to be an investment by
network members in maintaining social capital (Hayami, 2009; Zhan, 2012).

8
Social networking (Quanhe) as a business practice is essential in Vietnam. Quanhe is an equivalent
terminology of Chinese Guanxi, which has more or less the same meaning.3 The root of Quanhe,
according to Dell et al. (2018) was established in the Sinic historical stage, which was heavily
influenced by Chinese statecraft. Specifically, in this period, Daiviet (former name of Vietnam)
citizens were ruled by a strong, centralised state in which the village was the fundamental social
and administrative unit, leading to the establishment of “group identification”. Daiviet was governed
by China during the first millennium CE, and it maintained many features of the Chinese state
following independence (Meyer & Nguyen, 2005).

Quanhe, as a net of social networks is found to exert an important role in boosting firm investments
(Bi & Wang, 2018). There are two potential mechanisms leading to such a positive association, one
is the direct, non-financial effects, and the other one is the financial effects of social capital.

Concerning the non-financial effects, Cassar (2014) argues that having frequently interacted with
others in the same industries would help entrepreneurs update the newest trends in their markets,
including both material markets and product markets. By exchanging information, entrepreneurs
are able to build up a broader and more complete picture of opportunities (e.g., new technology)
and threats (e.g., new entrants) in their business environments, which then enable them to pursue a
more informed and timely investment strategy (De Carolis & Saparito, 2006). In the context of
Vietnam, Hanh Tien Thi and Tri Minh (2020) examine a sample of 153 Vietnamese firms and show
that social capital is positively related to firm performance with knowledge transfer and innovation
acting as mediators. They also evidently demonstrate that knowledge transfer and the company's
innovation are found to have a strong association with each other.

In addition, a strong network associated with a high level of trust may facilitate collaborative
investments among its members (Lai Xuan & Truong, 2005). In joint ventures built on strong trust
and mutual reliance, each party is likely to invest their most competitive resources/advantages (e.g.,
knowhow) to increase the likelihood of survival of the joint ventures, leading to higher value-added
and larger investment projects (Makino & Tsang, 2011).

In addition to the external benefits, a wider and stronger social network also benefits firm
investments by facilitating entrepreneurial innovation. Baron (2007) suggests that being exposed to
new information is of important effects in improving patterns recognition ability. Entrepreneurs

3
Guanxi is a social tie in which relative trust is high and is not dependent on third parties (Burt & Burzynska,
2017). Guanxi serves as a mechanism by which quasi-familial relations can be created to cultivate trust among
non-kin (Guo & Miller, 2010). This type of social tie is specific to China and other countries in the Southeast
Asian region (Bian, 2017; Luo et al., 2012).

9
who have a diversified networking background and experience are likely to come up with more
innovative ideas and plausible solutions. The reason is that a diversified pool of information from
different sources allows ones to discover and connect meaningful events which appear seemingly
irrelevant to people with less diversified social connections (Hsieh, 2016). For example, Nguyen
(2018) examines a set of Vietnamese SMEs (mostly household businesses) and find that
entrepreneurs who have wider social networks obtained from the previous entrepreneurial
activities make more investments into their current ventures compared to first-time entrepreneurs
with no business network.

For these reasons, it is arguably reasonable to expect that social capital, by providing small
businesses with valuable information, business opportunities, and collaboration opportunities, is
positively associated with firm investments. A hypothesis built upon these arguments is hardly new
in the extant literature. As such, we keep the test on the direct, non-financial association between
social networks and firm investments in this study as a confirmation test only.

2.3. Social capital and financing sources

Besides the direct, non-financial association, social capital may boost firm investments by
improving access to external loans, thus reducing the adverse effects of financing constraints on
firm investments.

In terms of informal finance, Heikkila et al. (2016) elaborate on the importance of relationship in
gaining access to external finance to argue that an individual’s social connections may affect access
to credit through two partly overlapping channels: social connections to loan officers and the need
to find guarantors for the loan. Since stronger and wider bonding social networks reduce
informational asymmetries, a person with more social capital is indeed perceived to form a lower
credit risk, and thus likely to obtain better credit access (Burt, 2007). This strand of argument is
endorsed by Chua et al. (2011) who argue that entrepreneurs must either use their personal capital
or if personal capital is lacking or insufficient, make use of other people’s social capital to
successfully obtain external finance. As such, they propose that family involvement increases a
venture’s ability to borrow family social capital for the purpose of obtaining debts. Meanwhile,
Menkhoff et al. (2012) investigate the financing of Thai small businesses and suggest that most
informal loans do not include any tangible assets as collaterals. Instead, lenders enforce
collateral-free loans through third-party guarantees and relationship lending. In the context of
Vietnam, McMillan and Woodruff (1999) examine relational contracting and find that a firm trusts
its customer enough to offer credit when the customer finds it hard to locate an alternative supplier.

10
A longer duration of trading relationship is associated with larger credit, as is prior information
gathering. This strand of literature thus highlights the importance of social capital in accessing
informal finance.

Moreover, a strong and binding network reduces asymmetric information and help establish
calculative trust among its members. Therefore, an entrepreneur, when successfully signal other ties
in the network that he/she is competent, may obtain corresponding favours (e.g., a better trade
credit scheme), which may then be used to finance (a proportion of) new investment projects
(Casey & O'Toole, 2014; Cull et al., 2009). Trade credit and reciprocal financial supports from local
business communities are important to small businesses’ investments, especially those operating in
developing countries because of their underdeveloped financial institutions (Cull et al., 2009).
Without such a system of networking and mutual trust, the flow of informal finance among small
businesses would not have been successfully activated. For these reasons, we propose the following
hypothesis:

Hypothesis H2a: The larger the networks associated with a firm, the more positive the
relationship between informal finance and firm investments.

In terms of formal finance, Nguyen et al. (2006) show that in the absence of effective market
institutions and business data, banks in Vietnam face considerable uncertainties (rather than risks)
in lending to private small businesses. Consequently, banks employ a combination of uncertainty
avoidance, and reliance on trust, in lending to their business clients. Given that access to finance is
crucial to making investments and fostering growth, maintaining strong ties with bank officials
appear to be a wise networking strategy. This argument is confirmed by Du et al. (2015) who
demonstrates that small businesses can improve access to (short-term) bank loans by adopting
strategies aimed at building social capital, namely entertaining and gift-giving to bank officials in
their social networks.

In addition, it is noteworthy that the banking systems in less developed countries are
monopolistically controlled by the states (Nguyen et al., 2016; Saez, 2001). In such a weak and
incomplete institutional system (both formal and informal institutions), bank officials, empowered
by substantial freedom from making lending decisions, are keen to favour relationship-based
instead of arms-length principles of transactions with an aim to seek private rents (Gjalt et al.,
2012). In such a situation, networks can serve as a means to reduce transaction costs for bank
officials. They are keen to make lending transactions with firms that are ‘in the circle’ – i.e., having a
well-established connection with them. The reason is that bank officials face time and attention

11
constraints; hence routine transactions are perceived cost-saving and safer to extract rents, and
thus are prioritised (Du & Mickiewicz, 2016).

Not only transaction costs, but agency costs are substantially reduced by social capital. To be
specific, networking serves as a mechanism of ‘information transfer’ in which firms can convey
information about their reliability and creditworthiness to bank officials (Zhan, 2012). This should
enable bank officials to build up a better picture of the financial and operating situations of the
firms, leading to a reduction in informational asymmetries and a greater willingness to forward
credit. For example, Le and Nguyen (2009) show that in the context of Vietnamese SMEs,
networking with customers and government officials promotes the use of bank loans. This finding is
recently re-confirmed by Pham and Talavera (2018) who investigate another set of Vietnamese
SMEs and find that social capital could facilitate loan applications: firms that have a closer
relationship with government officials and other business people can get loans of longer duration.

For these reasons, firms with more social capital are less financially constrained and are more likely
to successfully secure their investment projects. Therefore, we propose the following hypothesis:

Hypothesis H2b: The larger the networks associated with a firm, the more positive the
relationship between formal finance and firm investments.

3. Data and Methods

3.1. Data

To test the proposed hypotheses, this study employs the Small and Medium Enterprise (SME)
dataset published by the Central Institute for Economic Management (CIEM) of Vietnam. This
dataset is obtained through a collaboration of CIEM with two other institutions, namely the Institute
of Labor Science and Affairs of Vietnam (ILSAA), and the Development Economics Research Group
(DERG) of Copenhagen University.

The SME survey covers information on several operational aspects of small ventures in Vietnam,
including their production, sales structure, investment, and employment. In addition to formally
registered enterprises, the survey also samples a substantial number of micro-household
businesses to gain a comprehensive understanding of firm dynamics in Vietnam, where the informal
sector is particularly relevant (Carbonara et al., 2016). In addition to venture information,
household characteristics of the owner-managers and their social network information are also
extensively surveyed. The first full investigation was conducted in 2005 and has been carried out
every two years thereafter. Approximately 2,800 small businesses in 10 provinces across Vietnam

12
are randomly selected to participate in each survey. In this study, we employ the dataset over an
11-year period, from 2005 to 2015 (6 surveys in total).

It is noteworthy that this is an unbalanced panel as some firms may exit and other new firms may
join into the surveys. The survey sample was drawn randomly using the stratified sampling
technique to ensure that an adequate number of businesses with different ownership structures
was included for each province. We thus have micro firms (the majority), private firms,
partnerships, cooperatives, limited liability companies, and joint-stock companies. For a
comprehensive understanding of the survey, see Rand and Tarp (2007). The SME dataset is
unbalanced, and thus requires cleaning before using. Specifically, firms with no identification code
and non-meaningful accounting information were dropped.4 Moreover, the outliers are controlled
for by censoring the top and bottom 1% of observations in each variable, leaving a final sample of
15,851 firm-year observations, covering 3,715 small businesses.

3.2. Variables and measures

3.2.1. Firm investments

The primary dependent variable in this study is firm investments, measured by Investment variable,
which is the ratio of a firm’s investment value to its total capital over a period of two years (due to
the survey settings).

3.2.2. Financing sources

The primary independent variable is a set of firm financing strategies. We identify four mutually
exclusive financing strategies using the following two questions in the survey: ‘Has your firm
borrowed from banks or other formal credit institutions since the last survey?’ and ‘Has your firm
borrowed from informal sources including private moneylenders, relatives and friends to owners,
and other enterprises since the last survey?’

Firms that answer ‘no’ to both questions are coded 0, firms that use informal finance only are coded
1, firms that use formal finance only are coded 2, and firms that answer ‘yes’ to both questions are
coded 3. As such, we have a categorical variable with four potential outcomes: (1) No external
finance, (2) Informal finance only, (3) Formal finance only, and (4) Both formal and informal finance.
It is noteworthy that the four dummy variables are mutually exclusive.

3.2.3. Social networks

4
Including firms whose employees are smaller than zero and fixed assets are greater than total assets.

13
We measure the levels of effectiveness of social capital using the number of network ties that an
entrepreneur is effectively connected with. Specifically, we make use of the following item in the
questionnaire: ‘approximately, with how many people do you currently (presently) have regular
contact with?5 in each of the following categories: (1) Business people in the same sector (same
product as the reported industry codes); (2) Other business people in a different sector; (3) Bank
officials (including both formal and informal creditors); (4) Politicians and civil servants’.

As such, the survey provides information on three types of social ties, namely business-specific
networks, financing-specific networks, and political-specific networks. We construct a variable
named Social networks, which is the sum of all social ties in these categories to test the general effect
of social capital on firm investments. In the robustness check, we also examine the effects of each
type of networks in details.

3.2.4. Control variables

The model also controls for covariates that may influence firm investments. At the firm level, it
includes conventional variables such as firm age, firm size, industry, and types of ownership. These
variables represent the firm-specific characteristics that significantly determine the rate, value, and
frequency of investments (Nguyen, 2019). Besides that, we also control for entrepreneurial oriented
activities including exporting and innovating. The extant literature suggests that entrepreneurial
oriented firms are more likely to seek external finance to make larger and higher value-added
investment projects (Anderson et al., 2015). Next, a variable indicating firm membership status in
local industry associations is included to take into account the possibility that member firms may
invest more than non-member firms due to associations’ provided subsidies (Zhou, 2013). Also at
the firm level, we control for the level of liabilities (the ratio of liability values over total assets),
which are proven as a key determinant of investment decisions (both formal and informal)(Du et al.,
2015).

At the entrepreneurs’ individual-level, the model includes entrepreneurs’ gender and age as control
variables. These individual-specific factors play an essential role in investment decisions because
they indicate the patterns of cognitive styles of entrepreneurs, which may remarkably influence
their ability to recognise and evaluate business opportunities (Hayes & Allinson, 1998; Riding,
1997). Moreover, individuals’ previous start-up experience and education may also affect their
ability to recognise business opportunities (Arte, 2017; Nguyen, 2018). Therefore, the model also

5
Regular contact is defined as “a contact of least once every 3 months, which you find useful for your business
operations”.

14
controls for entrepreneur start-up experience, and educational background, which are measured by
a set of mutually exclusive dummy variables.

Finally, at the regional level, the model controls for time-variant provincial consumption power.
Firms located in provinces with stronger consumption power, measured as the average
consumption value per capita, may invest more than firms located in provinces with weaker
consumption power (Nguyen et al., 2018). We also control for time-invariant unobservable
provincial characteristics using a set of corresponding provincial dummy variables.

We acknowledge that it is important to control for investment opportunities in an investment

equation. Conventionally, sales revenues were employed as a proxy for investment opportunities
(Guariglia et al., 2011). Unfortunately, in this study we do not have sale-related variables. As such,
we take into account the effects of investment opportunities on investment decisions indirectly
using variables such as export, innovation, and provincial consumption. Firms would not export or
conduct innovative projects if they did not observe sufficient opportunities. Also, firms located in
provinces with stronger consumption power may find more investment opportunities as well.

Variable definitions and summary statistics are reported in Table 1. The correlation matrix is
reported in Appendix 1. On average, Vietnamese small businesses invest more than 10% of total
capital per year in the study period. In terms of financing strategies, 34.4% of sampled firms use no
external finance, 33.2% use informal loans, 12.2% use formal debts, and 20.2% use both financing
sources. These statistics indicate that a large number of small businesses (67.6%) in Vietnam still
have no access to formal finance, which may be a signal of financing constraints. In terms of social
networks, on average each entrepreneur in Vietnam has 32.5 active connections with business
people, banking officials, or local politicians.

<Table 1>

3.3. Specification and estimation

Following the extant literature on small business investment (Nguyen, 2019; Zhou, 2017), we
propose the following reduced-form investment equation:

( ) ( ) (
𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑖𝑔𝑡 = β0 + β1 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑛𝑔 𝑠𝑜𝑢𝑟𝑐𝑒𝑠𝑖𝑔𝑡 + β2 𝑆𝑜𝑐𝑖𝑎𝑙 𝑛𝑒𝑡𝑤𝑜𝑟𝑘𝑠𝑖𝑔𝑡 + β3 𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠𝑖𝑔𝑡 + 𝑣𝑡 + 𝑣𝑗 )
where 𝑖 denotes an individual business, 𝑔 is a province, and 𝑡 a year. As such, 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑖𝑔𝑡 is the

investment value of firm 𝑖 in province 𝑔 in year 𝑡. The term 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑛𝑔 𝑠𝑜𝑢𝑟𝑐𝑒𝑠𝑖𝑔𝑡 is a column vector

of four financing strategies: (1) use no external finance, (2) use informal finance only, (3) use formal

15
finance only, and (4) use both formal and informal finance. The term 𝑆𝑜𝑐𝑖𝑎𝑙 𝑛𝑒𝑡𝑤𝑜𝑟𝑘𝑠𝑖𝑔𝑡 is the total

number of business-specific networks, financing-specific networks, and political-specific networks

associated with a business. Then, we also test the effect of each respective type of networks on firm
investments. The term 𝐶𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠𝑖𝑔𝑡 comprises a set of covariates at individual level, firm

level, and regional level that may influence firm investments.

We are interested in the coefficients β1 and β2 as they indicate the association between

financing/networking strategies and firm investments. We, moreover, aim to explore the
moderating effects of social capital on the relationship between financing sources and investments.
As such, based on the benchmark specification, we add an interaction term
𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑛𝑔 𝑠𝑜𝑢𝑟𝑐𝑒𝑠𝑖𝑔𝑡 × 𝑆𝑜𝑐𝑖𝑎𝑙 𝑛𝑒𝑡𝑤𝑜𝑟𝑘𝑠𝑖𝑔𝑡.

The investment function also includes a time-specific component 𝑣𝑡, accounting for macro-business

cycle effects; an industry-specific characteristics 𝑣𝑗; and time-invariant provincial characteristics 𝑣𝑔,

which are controlled by the corresponding dummy variables. Firm-specific time-invariant

characteristics are captured in 𝑣𝑖. This study controls for this component by estimating the equation

using a fixed-effects technique. The fixed-effects estimator could deal, to some extent, with
unobservable heterogeneity and potential endogeneity of missing (time-invariant firm-specific)
variables in the model. Also, to reduce concerns of endogeneity, all variables that may suffer from
reverse effects are lagged one year. They include firm size, export, innovation, association, liability,
financing sources, and social networks. Finally, µ𝑖𝑡 is the idiosyncratic component of the error.

4. Results
4.1. Main results

Regression results are presented in Table 2. The specification tests indicate no serious issues with
the modelling. We also test multicollinearity among the regressors using variance inflation factor
(VIF) test and find no evidence of its presence. Columns 1 and 2 show the results of financing
sources and social networks separately. Columns 3 and 4 show the results of both variables entered
the equation simultaneously. The group of firms that use no external finance serves as the
benchmark.

The coefficients associated with financing sources, including using informal finance only, using
formal finance only, and using both sources of finance are positive and statistically significant. This

16
finding initially indicates that firms using external finance invest significantly more than firms using
no external finance.

<Table 2>

To compare the investment between pairs of financing sources, we conduct a set of Wald tests. The
test statistics (presented at the end of each column) confirm that firms using formal finance invest
more than firms using informal finance. However, firms using both sources of finance invest less
than firms using formal finance only. As such, hypothesis H1a and H1b are supported. However,
hypothesis H1c is not supported. This finding thus implies that entrepreneurs treat informal finance
as less desired alternative funding to formal finance.

In terms of the moderating effects of social capital on the relationship between financing sources
and firm investments, column 4 shows that the coefficients associated with the interaction term
between informal finance and social networks, and the interaction term between both sources of
finance and social networks are positive and statistically significant. Meanwhile, the coefficient
associated with the interaction term between formal finance and social networks is insignificant.
This finding thus implies that social capital is able to boost firm investment by improving access to
informal loans, but not formal debts. As such, hypothesis H2a is supported, and hypothesis H2b is
not supported.

Finally, the coefficients associated with the control variables also reveal some interesting
investment patterns. Older firms make more investments than their younger counterparts. This
could be attributed to reduced informational asymmetries when firms grow up. Also, firms holding
membership in local industry associations invest more, confirming the importance of knowledge
spillover and in funding investment projects using external finance. However, liability seems to
discourage firm investments. This could be due to the requirement from the creditors on high-debt
firms that restrict them from pursuing risky activities (i.e., making investments).

4.2. Robustness tests

4.2.1. Household business vs registered business

The sample of small businesses under investigation in this study includes both household
micro-businesses and registered businesses. Specifically, 65.29% of the sampled observations are
household businesses while the rest 34.71% are registered firms. These two types of firms may be
different in their access to finance as well as networking activities. For example, micro-household
businesses, compared to formally registered firms, may be more constrained in accessing to formal

17
finance such as bank loans as their natures of no official records of accounting numbers and small
scale of economic activities (Elston et al., 2016). Also, the networking activities of household
businesses may also be very limited due to their smallness and unprofessionalism (Nguyen &
Nordman, 2018). The regression results on the two samples are presented in Appendix 2.

The results show that both formal and informal finance are important to firm investment,
regardless of their legal forms. However, the effect of formal finance is much stronger than the effect
of informal finance. These findings are consistent with the main results on the total sample.
Interestingly, it is found that while social networks are important to registered firm investment,
they appear irrelevant to household business investment. This could be explained by the fact that
household businesses, due to their non-professional management, may not utilise their business
networks efficiently, leading to limited social capital extracted from the embedded networks
(Nguyen & Nordman, 2018). Also, their smallness in economic activities may restrict them from
making connections with key resource holders (e.g., higher level of local authorities) (Du &
Mickiewicz, 2016). For these reasons, there is little correlation between networking and firm
investment in household businesses. Meanwhile, registered firms may strategically manage their
social networks with an aim of increasing access to external resources. Also, they may actively
engage in political relationship building and extract benefits from such an activity.

Turning to the interaction terms between financing sources and social networks, it is found that
networking has no effect on access to formal finance in both sub-samples. This finding is consistent
with the main results on the total sample. However, social networks may help registered firms
improve access to informal finance. This effect is not found in household businesses. Once again,
this could be explained by the smallness in economic activities and unprofessional management of
household firms (Nguyen & Nordman, 2018). These characteristics fail to enable lenders to build up
a better picture of the financial and operating situations of the firms, leading to significant
informational asymmetries and a reluctance to forward credit. Meanwhile, registered businesses,
thanks to their formal legal forms and professional management may find it easier to build
relationship with lenders and obtain informal credit.

4.2.2. Four types of social networks

We also examine the effect of each type of social networks and the regression results are reported in
Appendix 3. The coefficients associated with the four types of social networks are mostly
insignificant or even negative in the interaction specification. This could be a result of
multicollinearity due to the presence of the interaction terms. However, the coefficients associated

18
with the interaction terms between informal finance and social networks and the interactions terms
between both sources of finance and social networks are statistically significant in some
specifications. Meanwhile, the coefficients associated with the interaction terms between formal
finance and social networks are not significant in any specification. These findings as such provide
some (weak) evidence that supports our proposed hypotheses.

4.2.3. Endogenous networking

We acknowledge that the regression results presented in previous sections may suffer from
endogeneity-related issues. For example, firms with stronger social network have higher
investment, but when firms make higher investment, they have more chance to increase social
network through the investment implications. Also, even though we controlled for several relevant
covariates, there may be a chance that the empirical setting encounters omitted-variable biases.

Therefore in this section, we employ the method proposed by (Oster, 2019), derived from the work
of Altonji et al. (2005), to calculate a set of consistent estimates of the bias-adjusted treatment
effects. This method is based on two assumptions: (1) a value for the relative degree of selection on
observed and unobserved variables δ (normally assumed to be equal selection, i.e., δ=1); and a value
for Rmax – R-squared obtained from a hypothetical regression of the outcome on treatment and on
both the observed and unobserved controls.6 Using these two inputs, an approximation of the
bias-adjusted treatment effect may be estimated through an examination of the ratio of the
movement in the regression coefficients in relation to the ratio of the movement in R-squared.

The networking variables in the main specification and the two sub-samples will be explored.
Appendix 4 presents the estimation results. Column (1) shows the regression coefficients without
controls (baseline effect). Column (2) shows the regression coefficients with observable controls
(controlled effect). Column (3) presents the bias-adjusted treatment effect with the assumptions
~ ~ ~
that δ=1, and 𝑅𝑚𝑎𝑥 = 𝑅 + (𝑅 − 𝑅˙), in which 𝑅 is R-squared obtained from the controlled

specification and 𝑅˙ is the R-squared obtained from the baseline specification (Bellows & Miguel,
2009). Column (4) presents the bias-adjusted treatment effect with the assumptions δ=1, and

6
If the outcome can be fully explained by the treatment and full control sets, then Rmax =1. However, in many
empirical settings, due to measurement errors for example, the outcome cannot be fully explained even if the
full control set is included.

19
 ~
𝑅𝑚𝑎𝑥 = 1. 3𝑅.7 Column (5) presents the value of δ for which the treatment effect becomes zero
~
under the assumption that 𝑅𝑚𝑎𝑥 = 1. 3𝑅. To facilitate the calculation of the non-biased treatment

effects, we estimate the coefficients in columns (1) and (2) using fixed effects.

The results show that the bias-adjusted coefficients are all positive in total sample and in the
sub-sample of registered firms. However, testing “social networks has no effects on household
business investment”’ generates a value smaller than 1 for δ. This is a signal that the distribution of
the bias-adjusted treatment effect of the variable includes value zero. This is consistent with the
finding using regression methods showing that social networks are irrelevant to household
business investment while they are positively associated with registered firm investment.

4.2.4. GMM estimation

In addition to the fixed effect, we also employ the system general method of moment (GMM) to
estimate the regression coefficients. The GMM approach could deal, to some extent, with potential
endogeneity in our model by using the lagged terms of the endogenous variables as valid
instrumental variables. Specifically, in the difference equations, we use the lagged 3 to 5-year terms
to instrument the endogenous variables. The specification tests suggest that this length of lag is
sufficiently deep to reduce the correlation between endogenous variables and the error terms, at
the same time, to remain relevant to the current terms of the endogenous variables (to be valid
instrumental variables). The system GMM, moreover, correct any possible finite sample bias by
omitting informative moment conditions using differences as instruments for level equations. In
level equations, we use the difference of endogenous variables lagged 2 to 4-year as valid
instruments. The regression results using GMM are reported in Appendix 5 and in general
consistent with our key arguments.

5. Discussion and Conclusion

Investment is important to small businesses. However, facing severe financing constraints, small
businesses can hardly satisfy their investment using only internally generated funds. As such, access
to external loans is an important determinant of investment decisions. This study investigates the
association between different financing sources and investments of small businesses in Vietnam.
Using a panel dataset of 3,715 small businesses in 11 years (2005-2015), we offer the initial

7
The factor 1.3 is suggested by (Oster, 2019). This value is obtained from an analysis of a randomised dataset
of 65 articles. This value was selected because it allows 90% of the results published in previous studies (lab
or field experiments) to survive the omitted-variable tests.

20
empirical evidence that firm investment is a function of financing sources. To be specific, we
propose a pecking order of financing sources in terms of investment. The pecking order in
ascending investment values is as follows: (1) firms using no external finance, (2) firms using
informal finance only, (3) firms using both formal and informal finance, and (4) firms using formal
finance only.

We further observe that social capital is of essential influence on firm investments. Its impacts are
channelled through two mechanisms. One is the direct, non-financial effect on firm investments
(e.g., providing additional information, business opportunities, and collaboration opportunities).
The other mechanism is the indirect effect by moderating the relationship between financing and
firm investments. Interestingly, we find that social networks are able to enhance access to informal
loans and boost firm investment subsequently. We observe no evidence showing that social
networks, even networking with bank officials, improve access to formal debts. In other words,
firms with more social networks are not statistically different from firms with less social networks
in terms of successfully securing formal (bank) loans.

This finding stands in sharp contrast to the majority of the extant research in small business
management and entrepreneurship. For example, Du et al. (2015) examine the extent to which
Chinese firms can improve access to external debts by adopting strategies aimed at building social
capital, namely entertaining and gift-giving to others in their social network. They find that
entertainment and gift-giving expenditure leads to higher levels of total and short-term debt (but
not long-term debt). Bank officers are exposed to higher levels of uncertainty in long-term debt
transactions as these loans are typically larger in terms of value and longer in terms of the maturity
period. For this reason, social capital is insufficient to protect bank officials from potential hold-ups
or information asymmetries occur after lending. This could be an explanation for the insignificant
moderating effect of social capital on the relationship between formal loans and firm investments.

This study sheds light on the debate about the relationship between formal and informal finance.
This relationship has drawn substantial research but remains elusive. Some studies propose a
peeking-order relationship between the two, in which firms will switch from informal to formal
finance as long as they are eligible to do so (Lee & Persson, 2016; Rahaman, 2011). The reason is
that formal loans are more stable, secure, and cheaper than informal loans. Meanwhile, other
studies argue for a complementary relationship between formal and informal finance because a
combination of both financing sources may best support firm diverse investment projects, in which
some projects are more suitable for informal rather than formal debts (Kislat, 2015; Steel et al.,

21
1997). In this study, instead of simply examining the relationship between the two, we propose and
find evidence for a pecking order of a set of financing strategies built on different combinations of
the two sources. Specifically, we propose that formal finance is the most desired financing source.
However, firms do not completely switch from informal loans to formal debts when they are able to
do so, but they need a transition period in which both sources of finance are employed to make
investments.

Moreover, this study also provides an initial understanding of the role of networks in the process of
financing investment projects. We propose that on top of the direct, non-financial effect of social
capital on firm investments, there is another indirect effect of networks on firm investments, i.e., the
moderating effect on access to external finance. As such, this study adds to the discussion on the
importance of social capital on small business management another dimension, that is the financial
effect of social capital.

This study has practical implications. The evidence that formal finance is strongly associated with
firm investments suggests that policymakers in less developed countries need to liberalise their
biased financial systems. Financing constraints are key obstacles to firm growth. As such, some
scholars have called for facilitating the informal financial sector to mitigate the adverse effects of
financing constraints. We suggest that informal finance can serve as a cushion for firms rationed out
by the formal sector. However, it has little contribution to firm investments and growth
subsequently. Therefore, building strong, well-regulated, and unbiased formal financial systems
should be the ultimate goal of policymakers in less developed countries (Saez, 2001).

Our findings also point to the importance of networking in gaining access to external loans.
Entrepreneurs with stronger and wider social networks may find it easier to obtain informal debts.
However, as we discussed, informal finance contributes insignificantly to investments. As such,
entrepreneurs need to be aware of the costs (e.g., time, attention) and the benefits of their
networking strategies. Over-built social networks may not result in sufficient capital for
investments but turn out to be unproductive and inefficient (in terms of making and maintaining
social ties).

This study is not without limitations that should be acknowledged, but they also provide potential
avenues for future research. First, the generalisability of this study may be limited because the
sample was restricted to Vietnamese small businesses that are exposed to Vietnamese management
styles and local governance/institution structures. Future studies, therefore, should extend the
proposed theoretical framework and re-test it in other contexts. Second, the dataset employed in

22
this study is quite small (more than 3,700 firms) in a short period of time (11 years, 6 surveys).
Future research should thus re-test the validity of our findings using a larger dataset with longer
survey periods. Finally, due to the limited information available in the SME survey, we are mostly
restricted to the use of dummy financing variables in this study. Future study may design
questionnaires that capture count values of financing sources, which would allow a deeper
understanding of the impact of financing strategies on firm investment.

23
 Tables and Figures

Table 1: Variable Definition and Summary Statistics

Variable Definition Mean SD Min Max
Investment Ratio of firm investment value over total capital 0.103 0.206 0 1.308
No external Take value 1 if firms did not use external finance 0.344 0.475 0 1
finance in the last two years, and 0 otherwise
Informal Take value 1 if firms use informal finance only in 0.332 0.471 0 1
finance the last two years, and 0 otherwise
Formal finance Take value 1 if firms use formal finance only in the 0.122 0.327 0 1
last two years, and 0 otherwise
Both financing Take value 1 if firms use both formal and informal 0.202 0.402 0 1
sources financing sources in the last two years, and 0
otherwise
Social networks A count variable, indicating the number people 32.512 30.470 1 203
that an entrepreneur currently has regular
contact with in the following four areas: (1)
business people in the same sector, (2) business
people in other sectors; (3) bank officials,
including both formal and informal creditors, and
(4) politicians and civil servants
Owner gender A dummy variable, which takes value 0 for female 0.640 0.480 0 1
and value 1 for male
Owner age Age of the business owners 45.652 10.481 25 73
Start-up A dummy variable, which takes value 0 if the 0.026 0.158 0 1
experience current business is the first venture and value 1if
the current business is not the first one
Owner A categorical variable, taking value 1 for doctoral 3.149 1.856 1 8
education degrees, 2 for masters, 3 bachelors, 4 college
degrees, 5 professional vocational degrees, 6
senior technical degrees, 7 junior technical
degrees, and 8 no degree
Firm age Number of years since firm establishment 19.087 12.857 3 86
Firm size A continuous variable, which is the natural log of 16.504 30.514 1 199
the number of employees (reported here the
number of employees)
Export A dummy variable, which takes value 0 if firms 0.062 0.241 0 1
did not export, and value 1 if firms have done
exports since the last survey
Innovation A dummy variable, which takes value 1 if firms 0.375 0.484 0 1
introduced new products, or improved current
products, or changed production process, and 0 if
firms did not do any of these innovations over the
last two years
Association A dummy variable with value 0 if firms do not join 0.233 0.423 0 1
any local industry association, and value 1 if firms
hold membership in at least one association
Liability The ratio of liability over total assets 0.096 0.189 0 1.078

24
 Province The value of average consumption of a province in 27.553 22.841 2.451 89.120
consumption a year depreciated to 2010 value, in million VND
per capita
Household Takes value 1 for household business, and 0 0.653 0.476 0 1
business otherwise
Sole Takes value 1 for sole proprietorship business, 0.081 0.273 0 1
proprietorship and 0 otherwise
Partnership Takes value 1 for partnership business, and 0 0.003 0.052 0 1
otherwise
Cooperative Takes value 1 for cooperative business, and 0 0.028 0.164 0 1
otherwise
Limited Take values 1 for LLC, and 0 otherwise 0.199 0.400 0 1
Liability
Company (LLC)
Joint stock Take values 1 for JSC, and 0 otherwise 0.003 0.051 0 1
company (JSC)
Joint venture Takes value 1 for joint venture with foreign 0.033 0.180 0 1
with foreign capital business, and 0 otherwise
capital
Note: The statistics are provided for 15,851 firm-year observations from 2005 to 2015. The data source is the
SME dataset published by the Central Institute for Economic Management (CIEM) of Vietnam.

Table 2: Regression Results

Variables (1) (2) (3) (4)
Informal finance 2.834*** 2.805*** 1.970***
(0.413) (0.413) (0.568)
Formal finance 15.519*** 15.529*** 15.080***
(1.014) (1.015) (1.381)
Both financing sources 14.948*** 14.907*** 12.406***
(0.738) (0.737) (1.025)
Social networks 0.016** 0.013* -0.017
(0.008) (0.007) (0.011)
Informal finance × Social networks 0.029*
(0.015)
Formal finance × Social networks 0.016
(0.030)
Both financing sources × Social networks 0.073***
(0.023)
Owner gender -0.394 -1.000 -0.399 -0.407
(0.597) (0.622) (0.597) (0.598)
Owner age -0.034 -0.032 -0.035 -0.037
(0.039) (0.040) (0.039) (0.039)
Start-up experience 1.213 1.308 1.190 1.075
(1.455) (1.510) (1.458) (1.462)
Owner education -0.163 -0.143 -0.163 -0.140

25
 (0.184) (0.193) (0.184) (0.184)
Firm age 1.310*** 1.079*** 1.317*** 1.300***
(0.150) (0.155) (0.150) (0.150)
Firm size -0.678 -0.685 -0.677 -0.601
(0.554) (0.572) (0.555) (0.555)
Export -1.804 -1.687 -1.819 -1.863
(1.723) (1.752) (1.723) (1.722)
Innovation -0.395 -0.460 -0.399 -0.408
(0.459) (0.484) (0.459) (0.460)
Association 3.822*** 4.838*** 3.752*** 3.606***
(1.098) (1.137) (1.097) (1.095)
Liability -6.541*** -7.383*** -6.584*** -6.600***
(2.068) (2.170) (2.069) (2.067)
Province consumption -0.127*** -0.147*** -0.131*** -0.123***
(0.028) (0.030) (0.028) (0.028)
Observations 15,851 15,851 15,851 15,851
Number of firms 3,715 3,715 3,715 3,715
VIF 2.743 3.034 3.287 4.982
R-squared 0.479 0.425 0.479 0.480
Adjusted R-squared 0.274 0.200 0.274 0.278
Wald test Informal finance = Formal finance 156.65 61.53 90.68
p value 0.00 0.00 0.00
Wald test Formal finance = Both financing sources 3.46 5.30 5.07
p value 0.06 0.02 0.02
Note: The dependent variable is firm investment. Firms using no external finance serve as the benchmark
financing source. All estimations include full sets of two-digit industry dummies, 10 provincial dummies, and
6-year dummies. Standard errors and test statistics are asymptotically robust to heteroscedasticity. Variables
firm size, export, innovation, association, liability, financing sources, and social networks are lagged one
period. VIF is variance inflation factor test for multicollinearity. Wald test Informal finance = Formal finance
under the null that the coefficient associated with Informal finance variable is equal to the coefficient
associated with Formal finance variable. Wald test Formal finance = Both financing sources under the null that
the coefficient associated with Formal finance variable is equal to the coefficient associated with Both
financing source.

26
 Appendix 1: Correlation Matrix

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
Investment (1)
Financing sources (2) 0.35
Social networks (3) 0.06 0.10
#
Owner gender (4) 0.01 0.00# -0.04
Owner age (5) -0.11 -0.11 -0.04 0.15
Start-up experience (6) 0.05 0.04 0.02 0.05 0.04
Owner education (7) 0.07 0.07 0.16 -0.05 -0.08 0.00#
Firm age (8) -0.13 -0.12 -0.04 0.03 0.32 -0.04 -0.09
Firm size (9) 0.10 0.18 0.16 -0.03 -0.04 0.01# 0.20 -0.06
Export (10) 0.07 0.12 0.07 -0.04 -0.05 0.02 0.19 -0.07 0.35
Innovation (11) 0.11 0.14 0.05 0.07 -0.09 0.04 -0.03 -0.12 0.12 0.11
#
Association (12) 0.12 0.03 -0.03 0.03 -0.01 0.06 -0.12 -0.07 0.09 0.06 0.24
#
Liability (13) 0.36 0.51 0.07 0.00 -0.11 0.07 0.02 -0.16 0.17 0.12 0.18 0.12
Provincial consumption (14) -0.10# -0.13 0.12 -0.09 -0.04 -0.05 0.39 0.00 0.05 0.11 -0.16 -0.30 -0.19
Note: The statistics are provided for 15,851 firm-year observations from 2005 to 2015. The data source is the SME dataset published by the Central
Institute for Economic Management (CIEM) of Vietnam. Coefficients with # are not significant at 1%.

Appendix 2: Household Business and Registered Firms

(1) (2) (3) (4) (5) (6) (7) (8)

Household Household Household Household Registered Registered Registered Registered
Informal finance 2.531*** 2.529*** 2.889*** 4.922*** 4.768*** 1.393
(0.427) (0.427) (0.566) (1.095) (1.101) (1.475)
Formal finance 14.003*** 14.002*** 13.958*** 19.913*** 19.925*** 20.040***
(1.176) (1.176) (1.571) (2.068) (2.072) (2.911)
Both financing sources 14.192*** 14.187*** 11.624*** 18.059*** 17.911*** 14.552***
(0.868) (0.867) (1.328) (1.476) (1.476) (2.004)

27
 Social networks 0.008 0.001 -0.009 0.029** 0.027** -0.037
(0.009) (0.008) (0.009) (0.014) (0.013) (0.028)
Informal finance × Social networks -0.011 0.088***
(0.013) (0.034)
Formal finance × Social networks 0.002 -0.001
(0.037) (0.053)
Both financing sources × Social networks 0.085** 0.085**
(0.036) (0.039)
Owner gender -0.419 -0.794 -0.421 -0.460 -0.407 -1.599 -0.359 -0.344
(0.587) (0.617) (0.588) (0.589) (1.353) (1.421) (1.351) (1.356)
Owner age -0.048 -0.047 -0.048 -0.051 -0.010 -0.011 -0.013 -0.020
(0.043) (0.045) (0.043) (0.043) (0.076) (0.078) (0.075) (0.076)
Start-up experience 1.275 2.455 1.280 1.134 0.515 0.019 0.365 0.372
(1.836) (1.808) (1.837) (1.863) (2.265) (2.411) (2.276) (2.294)
Owner education -0.164 -0.058 -0.163 -0.153 0.012 -0.188 -0.012 0.056
(0.206) (0.217) (0.207) (0.207) (0.341) (0.358) (0.339) (0.337)
Firm age 1.407*** 1.069*** 1.408*** 1.418*** 1.053** 1.169** 1.051** 1.007**
(0.153) (0.157) (0.153) (0.154) (0.441) (0.457) (0.440) (0.443)
Firm size 0.836 0.879 0.835 0.894 -1.628* -1.709* -1.594* -1.533*
(0.622) (0.655) (0.623) (0.622) (0.874) (0.908) (0.877) (0.879)
Export -2.506 -2.832 -2.511 -2.712 -0.726 -0.255 -0.726 -0.691
(1.845) (1.842) (1.846) (1.870) (2.277) (2.345) (2.279) (2.278)
Innovation -0.377 -0.552 -0.375 -0.318 -0.413 -0.316 -0.477 -0.615
(0.495) (0.530) (0.496) (0.497) (0.995) (1.033) (0.992) (1.003)
Association 1.873 3.366** 1.869 1.824 5.112*** 5.764*** 4.943*** 4.771***
(1.356) (1.381) (1.356) (1.354) (1.676) (1.749) (1.673) (1.671)
Liability -4.937* -5.515* -4.938* -4.835* -7.606** -9.086*** -7.760** -8.024**
(2.709) (2.874) (2.710) (2.689) (3.229) (3.367) (3.236) (3.214)
Province consumption -0.139*** -0.141*** -0.140*** -0.138*** -0.076 -0.149** -0.078 -0.065
(0.026) (0.028) (0.027) (0.027) (0.072) (0.075) (0.072) (0.072)
Observations 6,432 6,446 6,432 6,432 3,008 3,010 3,008 3,008
Number of firms 0.476 0.414 0.476 0.478 0.468 0.418 0.469 0.472
VIF 4.215 4.250 4.521 5.364 4.221 4.215 4.366 5.527
R-squared 0.461 0.414 0.463 0.478 0.468 0.418 0.469 0.472
Adjusted R-squared 0.271 0.186 0.271 0.273 0.227 0.155 0.228 0.231
Wald test Informal finance = Formal finance 96.18 96.2 48.83 53.39 54.21 41.8

28
 p value 0 0 0 0 0 0
Wald test Formal finance = Both financing
sources 0.02 0.02 1.47 0.88 1.03 3.53
p value 0.881 0.884 0.226 0.349 0.311 0.06
Note: The dependent variable is firm investment. Columns 1-4 are for household businesses. Columns 5-8 are for registered firms. Firms using no
external finance serve as the benchmark financing source. All estimations include full sets of two-digit industry dummies, 10 provincial dummies, and
6-year dummies. Standard errors and test statistics are asymptotically robust to heteroscedasticity. Variables firm size, export, innovation, association,
liability, financing sources, and social networks are lagged one period. VIF is variance inflation factor test for multicollinearity. Wald test Informal
finance = Formal finance under the null that the coefficient associated with Informal finance variable is equal to the coefficient associated with Formal
finance variable. Wald test Formal finance = Both financing sources under the null that the coefficient associated with Formal finance variable is equal to
the coefficient associated with Both financing source.

Appendix 3: Four Types of Social Networks

(1) (2) (3) (4) (5) (6) (7) (8)
Informal finance 2.877*** 2.755*** 2.831*** 2.550*** 2.554*** 2.337*** 2.852*** 2.250***
(0.414) (0.418) (0.414) (0.530) (0.425) (0.437) (0.416) (0.483)
Formal finance 15.497*** 14.872*** 15.570*** 15.788*** 15.056*** 14.645*** 15.519*** 14.610***
(1.015) (1.212) (1.015) (1.240) (1.030) (1.400) (1.023) (1.240)
Both financing sources 14.988*** 15.178*** 14.954*** 12.957*** 14.327*** 14.823*** 14.936*** 14.444***
(0.738) (0.756) (0.737) (0.926) (0.773) (0.783) (0.740) (0.872)
Same business-specific networks -0.029 -0.017**
(0.021) (0.009)
Informal finance × Same business-specific networks 0.017*
(0.009)
Formal finance × Same business-specific networks 0.100
(0.105)
Both financing sources × Same business-specific networks -0.015
(0.021)
Different business-specific networks 0.025** -0.005
(0.011) (0.016)
Informal finance × Different business-specific networks 0.017

29
 (0.022)
Formal finance × Different business-specific networks -0.012
(0.043)
Both financing sources × Different business-specific networks 0.101***
(0.033)
Financing-specific networks 0.432*** -0.415
(0.146) (0.307)
Informal finance × Financing-specific networks 0.751**
(0.331)
Formal finance × Financing-specific networks 0.858
(0.667)
Both financing sources × Financing-specific networks 0.443
(0.321)
Political-specific networks 0.078 -0.252
(0.113) (0.163)
Informal finance × Political-specific networks 0.469**
(0.220)
Formal finance × Political-specific networks 0.635
(0.502)
Both financing sources × Political-specific networks 0.381
(0.278)
Owner gender -0.379 -0.431 -0.376 -0.385 -0.420 -0.452 -0.421 -0.390
(0.598) (0.595) (0.597) (0.595) (0.600) (0.602) (0.599) (0.600)
Owner age -0.033 -0.034 -0.035 -0.036 -0.037 -0.037 -0.037 -0.039
(0.039) (0.039) (0.039) (0.039) (0.039) (0.039) (0.039) (0.039)
Start-up experience 1.189 1.183 1.131 1.035 1.173 1.189 1.208 1.209
(1.451) (1.454) (1.456) (1.461) (1.462) (1.465) (1.452) (1.462)
Owner education -0.166 -0.169 -0.164 -0.155 -0.167 -0.173 -0.177 -0.179
(0.184) (0.185) (0.184) (0.184) (0.188) (0.188) (0.185) (0.185)
Firm age 1.301*** 1.315*** 1.309*** 1.313*** 1.303*** 1.312*** 1.323*** 1.317***
(0.150) (0.149) (0.150) (0.150) (0.151) (0.151) (0.151) (0.151)
Firm size -0.697 -0.741 -0.682 -0.636 -0.702 -0.680 -0.713 -0.699

30
 (0.554) (0.555) (0.555) (0.554) (0.560) (0.560) (0.558) (0.558)
Export -1.820 -1.819 -1.832 -1.918 -1.900 -1.999 -1.864 -1.935
(1.721) (1.722) (1.721) (1.722) (1.733) (1.735) (1.736) (1.739)
Innovation -0.391 -0.396 -0.408 -0.426 -0.378 -0.388 -0.374 -0.384
(0.459) (0.459) (0.459) (0.459) (0.467) (0.468) (0.462) (0.462)
Association 3.855*** 3.895*** 3.793*** 3.665*** 3.788*** 3.871*** 3.763*** 3.758***
(1.097) (1.100) (1.096) (1.095) (1.103) (1.101) (1.107) (1.106)
Collateral -6.473*** -6.445*** -6.554*** -6.545*** -6.624*** -6.642*** -6.442*** -6.491***
(2.070) (2.062) (2.067) (2.061) (2.079) (2.084) (2.085) (2.087)
Province consumption -0.125*** -0.129*** -0.129*** -0.127*** -0.128*** -0.127*** -0.129*** -0.126***
(0.028) (0.028) (0.028) (0.028) (0.028) (0.028) (0.028) (0.028)
Observations 15,851 15,851 15,851 15,851 15,851 15,851 15,851 15,851
Number of firms 3,715 3,715 3,715 3,715 3,715 3,715 3,715 3,715
VIF 4.383 4.092 4.396 4.984 4.365 4.212 4.964 4.224
R2 0.479 0.480 0.479 0.481 0.480 0.480 0.479 0.479
Adjusted R2 0.272 0.274 0.274 0.274 0.273 0.273 0.273 0.272
Note: The dependent variable is firm investment. Firms using no external finance serve as the benchmark financing source. All estimations include full
sets of two-digit industry dummies, 10 provincial dummies, and 6-year dummies. Standard errors and test statistics are asymptotically robust to
heteroscedasticity. Variables firm size, export, innovation, association, liability, financing sources, and social networks are lagged one period. VIF is
variance inflation factor test for multicollinearity. Wald test Informal finance = Formal finance under the null that the coefficient associated with
Informal finance variable is equal to the coefficient associated with Formal finance variable. Wald test Formal finance = Both financing sources under the
null that the coefficient associated with Formal finance variable is equal to the coefficient associated with Both financing source.

Appendix 4: Biased-Adjusted Results

Bias-adjusted beta Bias-adjusted beta Delta for beta=0, given

Baseline effect Controlled effect ~ ~ ~ ~
Treatment effect
[R2] [R2] 𝑅𝑚𝑎𝑥 = 𝑅 + (𝑅 − 𝑅˙) 𝑅𝑚𝑎𝑥 = 1. 3𝑅 𝑅𝑚𝑎𝑥 = 1. 3𝑅

Networking (Total sample) 0.016 [0.069] 0.013 [0.131] 0.009 0.010 2.994
Networking (household business sample) 0.006 [0.066] 0.001 [0.141] -0.003 -0.002 0.286
Networking (Registered firm sample) 0.028 [0.078] 0.027 [0.127] 0.024 0.025 9.027

31
Note: This table shows the bias-adjusted treatment effects for owner gender and female employee rate. Column (1) shows the regression coefficients
without controls (baseline effect). Column (2) shows the regression coefficients with observable controls (controlled effect). Column (3) presents the
~ ~ ~
bias-adjusted treatment effect with assumptions that δ=1, and 𝑅 𝑚𝑎𝑥
= 𝑅 + (𝑅 − 𝑅˙), in which 𝑅 is R-squared obtained from the controlled specification
and 𝑅˙ is the R-squared obtained from the baseline specification. Column (4) presents the bias-adjusted treatment effect with assumptions δ=1, and
~ ~
𝑅𝑚𝑎𝑥 = 1. 3𝑅. Column (5) presents the value of δ for which the treatment effect becomes zero under the assumption that 𝑅𝑚𝑎𝑥 = 1. 3𝑅. The values in [.]
are the R-squared

Appendix 5: GMM Results

(1) (2) (3) (4) (5)

Lagged investment -19.740*** 11.227 -9.180 2.867 11.829
(6.718) (17.892) (7.169) (1.953) (13.290)
Informal finance 2.376*** 2.633*** 3.006*** 3.036*** 3.628
(0.443) (0.425) (0.324) (0.461) (9.029)
Formal finance 15.621*** 14.830*** 15.897*** 15.174*** 23.207*
(1.147) (1.177) (1.067) (1.546) (12.707)
Both financing sources 13.725*** 15.538*** 15.202*** 15.183*** 12.180
(0.885) (0.835) (0.708) (0.828) (8.016)
Social networks -0.009
(0.007)
Informal finance × Social networks 0.020*
(0.011)
Formal finance × Social networks -0.007
(0.022)
Both financing sources × Social networks 0.054***
(0.019)
Same business-specific networks -0.013
(0.010)
Informal finance × Same business-specific networks 0.014
(0.010)

32
 Formal finance × Same business-specific networks 0.079
(0.097)
Both financing sources × Same business-specific networks 0.001
(0.013)
Different business-specific networks 0.004
(0.007)
Informal finance × Different business-specific networks -0.005
(0.007)
Formal finance × Different business-specific networks -0.025
(0.031)
Both financing sources × Different business-specific networks 0.023
(0.018)
Financing-specific networks 0.085**
(0.038)
Informal finance × Financing-specific networks 0.263*
(0.140)
Formal finance × Financing-specific networks 0.713
(0.677)
Both financing sources × Financing-specific networks -0.022
(0.125)
Political-specific networks -5.096*
(2.750)
Informal finance × Political-specific networks 6.061*
(3.198)
Formal finance × Political-specific networks 0.564
(6.092)
Both financing sources × Political-specific networks 6.878**
(3.311)
Owner gender 0.565 0.179 0.493 0.352 -0.208
(0.392) (0.445) (0.390) (0.390) (0.702)
Owner age -0.089*** -0.062*** -0.083*** -0.078*** -0.064*
(0.021) (0.024) (0.021) (0.021) (0.033)

33
 Start-up experience 0.829 0.406 0.705 0.534 -0.546
(1.232) (1.335) (1.215) (1.232) (1.739)
Owner education -0.204 -0.164 -0.173 -0.076 -0.026
(0.135) (0.195) (0.136) (0.135) (0.220)
Firm age -0.049*** -0.006 -0.039** -0.033** -0.028
(0.017) (0.029) (0.017) (0.014) (0.046)
Firm size 2.371*** 0.254 1.948** 0.130 0.227
(0.753) (2.826) (0.775) (0.308) (3.268)
Export 0.519 6.573 0.451 -1.348 -0.467
(2.423) (5.831) (2.152) (1.165) (6.068)
Innovation -0.312 1.834 -0.180 -0.353 -0.464
(0.610) (4.226) (0.587) (0.411) (4.110)
Association 1.555* 1.999* 1.783* 2.489*** 1.531
(0.917) (1.143) (0.928) (0.886) (1.539)
Collateral 8.140* 4.152 1.329 -5.357*** 13.009
(4.357) (13.332) (4.459) (1.961) (14.370)
Province consumption -0.098*** -0.119*** -0.120*** -0.135*** -0.075
(0.031) (0.029) (0.024) (0.024) (0.145)
Observations 15,851 15,851 15,851 15,851 15,851
Number of firms 3,715 3,715 3,715 3,715 3,715
VIF 4.346 4.345 4.657 4.335 4.753
Hansen J 0.015 0.259 0.021 0.064 0.824
AR(2) 0.104 0.313 0.604 0.379 0.202
Note: The dependent variable is firm investment. Firms using no external finance serve as the benchmark financing source. All estimations include full
sets of two-digit industry dummies, 10 provincial dummies, and 6-year dummies. Standard errors and test statistics are asymptotically robust to
heteroscedasticity. Endogenous variables are firm size, export, innovation, association, liability, financing sources, and social networks. These variables
are instrumented by the lagged values. The instruments for the difference equation are the lagged 3 to 5-year level-variables. The instruments for level
equation are the lagged 2 to 4-year difference-variables. VIF is variance inflation factor test for multicollinearity. Hansen (J) is over-identification test,
under the null that the overidentifying restrictions are valid, the statistic is asymptotically distributed as a chi-square variable. AR(2) is autocorrelation
test under the null that there is no autocorrelation in the transformed equations.

34
 Data Availability Statement: the data that support the findings of this study are available from the

corresponding author upon reasonable request.

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