Financing Entrepreneurship and the Old-Boy Network

We study entrepreneurs’ start-up financing from banks and local financiers. An informalnetwork, whose membership cannot be observed by outsiders, conveys the good signals itgets about the hidden types of network entrepreneurs to local financiers, which are thenreflected in different loan terms. We show that there are winners and losers as a result of thenetwork even among its members. Because all projects have positive net value, it is efficientto finance them even in the absence of a network. Thus, the formation of the network isinefficient as entrepreneurs incur networking costs for purely redistributive gains in the formof better loan terms as network members....