Value Creation Through Employer Loans: Evidence of Informal Lending to Employees at Small, Labor-Intensive Firms

Abstract

At small and medium-sized enterprises (SMEs), cash-strapped employees frequently request loans from employers because they cannot obtain money on reasonable terms elsewhere for exigent needs. In turn, employers decide whether to lend the money through formal (i.e., written, contractual) loans or more informal “off-the-book” (OTB) loans. Our exploration of this understudied source of credit unearths important questions about the reasons employers lend money to employees, the manner in which they decide to make formal or informal loans, and the coveted benefits employers derive from lending to their workers. Considering the pervasiveness and significance of loan choices among small firms, and the absence of studies on the topic, we tackle these questions through an analysis of 459 informal and formal loans issued by 83 small business owners to their employees. The results show that the issuance of OTB loans is a key tactic for employers to manage resource dependencies with valued workers.