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This paper exploits a comprehensive data set on business credit decisions to examine the importance of financing constraints for the evolution of the firm size distribution. The survey of small business finances provides information on whether a firm was in need of external financing. Firms without access to external financing—either because they were denied credit or because they did not apply for credit because they expected to be denied credit—are significantly smaller. To tighten the link between financing constraints and firm dynamics, I estimate the effect of financing constraints on subsequent employment growth and find that firms without access to external financing exhibit up to 3.5 % points lower annual employment growth than do their unconstrained counterparts. These findings suggest that financing constraints are a potentially important factor for understanding firm dynamics.
