Which SMEs are Appropriate to be Government Backed?: The Case of a Korean Policy Loan Program

We examine two policy questions: (i) which SMEs are participating in and are accepted for a policy loan program?; (ii) what are the private and social returns of policy loans for the approved firms? To correct probable selection bias arising from using only firms accepted for a policy loan program, Heckman-type of a selection model is estimated by using large sample financial statement data collected. Our adoption equation shows that the government authority is conservative when approving policy loan beneficiary. It is likely to approve firms with more experienced firms and higher net profits, while smaller in assets. However, the lender as a benevolent social planner does not significantly approve SMEs in financial difficulty associated with low liquidity and high debt ratio. After controlling for characteristics of approved SMEs, we figured out that policy loans do have positive effects on improving net profits and sales for SMEs. But the effect of policy loans on the employment is not prompt. We also found that public financial support for SMEs are more effective for the improvement of sales and net profits of bigger and experienced business than the smaller and younger companies. Whereas, although it is not prompt with the investment, the employment effect is larger for the younger companies and SMEs on its early development stage. The general belief that policy loans help attract liquidity of SMEs and thereby improve their private and social returns should be corrected. We suggest that government policy measures are not necessarily to be conservative, but should be very specific to correct corresponding types of market failures.