Employer Loan Choices to Employees and the Profitability of Small, Labor-Intensive Firms

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 choose whether to lend the money through formal (i.e. written, contractual, tax compliant) loans or more informal “off the book” loans.  Considering the pervasiveness and significance of this choice among small firms, and the absence of studies that address it, we consider when employers would issue OTB versus formal loans and to what effect. Through an analysis of 459 informal and formal loans issued by 83 small business owners to their employees, we show when the choice to make OTB loans versus formal ones helps generate employee goodwill and commitment that confers value for small firm owner/employers. Analysis reveals how employers consider the vulnerability of high performing employees’ when issuing OTB loans in a manner that allows employers to increase firm value.  Overall, OTB loans emerge as a pervasive, ubiquitous and valuable means of eliciting high-performing work from recipients.