1. Research Spotlight: Testing the Financial Capability of Small Business Owners

    September 5, 2018

    In addition to hosting conferences and monthly “blue bag” lunch talks, the Center conducts research on a wide variety of topics. This month’s article discusses new research that faculty director Michael S. Barr has been conducting with collaborators Eldar Shafir of Princeton University (Psychology) and Antoinette Schoar of MIT’s Sloan School of Management (Finance), aided by PhD candidates Nelson Saldaña and Lydia Wileden (Sociology). We interviewed Saldaña about the project.

    Q. Please describe the Small Business Owners Research Project, and why it matters. What are you trying to do?

    A. The project is an assessment of the financial capability and legal literacy of small business owners, which are defined as those employing less than 20 employees and constitute the majority of businesses in the US. Several studies have tested financial literacy at the individual or household consumer level, and how a person’s financial capability impacts a myriad of financial outcomes and behaviors. Existing research suggests that the average American does not have a sophisticated understanding of the concepts necessary to make sound financial decisions. However, less is known about how the financial literacy of business owners compares to that of the general population.

    The assumption is that business owners, by virtue of owning a business and having to deal with financial transactions on a daily basis, should be more financially literate than the average consumer. Policies like the Truth in Lending Act acknowledge the shortcomings of the average consumer and have thus created protections for them in the form of things like APR disclosure or limitations on predatory behavior. However, the same kinds of protections are not forwarded to business owners because they are assumed to be more advanced or alternatively, able to outsource this work to experts. To give you more background, Michael Barr’s work with the Detroit Neighborhood Entrepreneurs Project seemed to suggest to him that assumptions about the sophistication of small business owners and their access to resources is incorrect. Hence, the main research question of the project is to determine what the financial literacies of small business owners are, how this compares with non-business owners, and how it relates to small business outcomes such as firm death, growth (as measured by sales, employees), access to loan terms that are favorable, and other factors. The project is multi-tiered so in addition to this main question, we are also interested in:

    • How to measure the financial literacy of small business owners since owning a business has a different skill set than the average consumer. Thus, questions about what a stock is, which are used in traditional assessments of financial literacy, may not be as relevant;
    • The effectiveness of educational trainings in teaching financial and legal literacy;
    • Examining biases of business owners and how they inform financial decisions related to their business;
    • Testing experiments that use interventions using the principles of behavioral economics to see how financial decisions can be improved. This portion is key especially because it may be that while financial literacy is important, it’s providing information and knowledge at critical decision points that matter (i.e. at the time of loan offer).

    Q. Can you explain who your collaborators are and the interdisciplinary nature of this project?

    A. We have several academic and community partners. In addition to Dean Barr, the other PIs include Eldar Shafir and Antoinette Schoar. Professor Shafir is the Class of 1987 Professor of Behavioral Science and Public Policy, Professor of Psychology and Public Affairs and the Inaugural Director of Princeton’s Kahneman-Treisman Center for Behavioral Science and Public Policy. He is a leading expert in behavioral economics. Antoinette Schoar, Professor of Entrepreneurship and Finance at MIT Sloan School of Management brings a wealth of knowledge about entrepreneurs and finance. Shafir and Schoar are also co-founders of ideas42, a non-profit that uses insights from behavioral economics and psychology to solve social problems.

    We are also partnering with Joyce Klein from FIELD at the Aspen Institute and Gwendy Donaker Brown from Opportunity Fund who work in the fields of small business policy and lending. We intend to pilot and test interventions through their clients.

    Lastly, we are also seeking additional partnerships with other institutions who serve small business owners.

    In terms of students other than myself (a sociologist), we have: Lydia Wilden, a PhD candidate in sociology, Lucas Misera, a Masters of public policy student, and two undergraduates, Cole Magoon and Ashton Smith. Earlier in the project, we were aided by now-graduated MPP student Carmille Lim.

    Q. How would you describe your experience as an RA with the CFLP?

    A. I have truly enjoyed working on the project, because I have been able to use my knowledge about small business owners in ways that I have not been able to in my dissertation, which looks at the non-economic impacts of small business owners and the context and conditions in which they participate in social exchange with the communities they are located in. In particular, this project has been super helpful in helping me think about my dissertation and its own impacts on policies and how to frame it so that my research can impact business owners. It’s also been a joy to work in the context of a multidisciplinary team, I’ve learned so much about behavioral economics, and as a sociologist, who tends to think about groups, I was a bit apprehensive about it due to my own disciplinary biases. However, being able to see the sociological components that inform these more individually-driven behaviors has really expanded my thinking. Also, getting to work with really smart and passionate people!

    Want to learn more? Nelson also provided a financial literacy quiz: (Take the quiz – answers are at the bottom!)

    Financial Literacy Questions:

    * Denotes 3 most commonly asked questions when assessing financial literacy

    Basic Level:

    1. *Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
    a. More than $102
    b. Exactly $102
    c. Less than $102
    d. I don’t know

    2. Suppose you had $100 in a savings account and the interest rate is 20% per year and you never withdraw money or interest payments. After 5 years, how much would you have in this account in total?
    a. More than $200
    b. Exactly $200
    c. Less than $200
    d. I don’t know

    3. *Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?
    a. More than today
    b. Exactly the same
    c. Less than today
    d. I don’t know

    4. Assume a friend inherits $10,000 today and his sibling inherits $10,000 three years from now. Who is richer because of the inheritance?
    a. My friend
    b. His sibling
    c. They are equally rich
    d. I don’t know

    5. Suppose that in the year 2010, your income has doubled and prices of all goods have doubled too. In 2010, how much will you be able to buy with your income?
    a. More than today
    b. The same
    c. Less than today
    d. I don’t know

    Advanced Level:

    6. Which of the following statements describe the main function of the stock market?
    a. The stock market helps to predict stock earnings
    b. The stock market results in an increase in the price of stocks
    c. The stock market brings people who want to buy stocks together with those who want to sell stocks
    d. None of the above
    e. I don’t know

    7. Which of the following statements about mutual funds is correct?
    a. Once one invests in a mutual fund, one cannot withdraw the money in the first year
    b. Mutual funds can invest in several assets, for example invest in both stocks and bonds
    c. Mutual funds pay a guaranteed rate of return which depends on their past performance
    d. None of the above
    e. I don’t know

    8. If the interest rates fall, what should happen to bond prices?
    a. They should rise
    b. They should fall
    c. They should stay the same
    d. I don’t know

    9. *True or false? Buying a single company stock usually provides a safer return than a mutual fund.
    a. True
    b. False
    c. I don’t know

    10. True or false? Stocks are normally riskier than bonds.
    a. True
    b. False
    c. I don’t know

    11. Considering a long time period (for example 10 or 20 years), which asset normally gives the highest return?
    a. Savings accounts
    b. Bonds
    c. Stocks
    d. I don’t know

    12. Normally, which asset displays the highest fluctuations over time?
    a. Savings accounts
    b. Bonds
    c. Stocks
    d. I don’t know

    13. When an investor spreads his money among different assets, does the risk of losing money:
    a. Increase
    b. Decrease
    c. Stay the same
    d. I don’t know

    14. If you buy a company’s stock…
    a. You own a part of the company
    b. You have lent money to the company
    c. You are liable for the company’s debts
    d. The company will return your original
    e. I don’t know

    15. If you buy a company’s bond…
    a. You own a part of the company
    b. You have lent money to the company
    c. You are liable for the company’s debts
    d. You can vote on shareholder resolutions 5 I don’t know

    16. If you were to invest $1000 in a stock mutual fund, it would be possible to have less than $1000 when you withdraw your money.
    a. True
    b. False
    c. I don’t know

    17. A stock mutual fund combines the money of many investors to buy a variety of stocks.
    a. True
    b. False
    c. I don’t know

    18. It is hard to find mutual funds that have annual fees of less than one percent of assets.
    a. True
    b. False
    c. I don’t know

    19. Mutual funds pay a guaranteed rate of return.
    a. True
    b. False
    c. I don’t know

     

    Answers: 1) a; 2) a; 3) c; 4) a; 5) b; 6) c; 7) b; 8) a; 9) b; 10) a; 11) c; 12) c; 13) b; 14) a; 15) b; 16) a; 17) a; 18) b; 19) b