Abstract
Highly leveraged small businesses cannot obtain enough credit because of the debt overhang problem. Therefore, highly leveraged firms may lose potential profits from profitable investment opportunities in which they are unable to invest. On the other hand, highly leveraged small businesses can enhance their performance because banks and trade creditors monitor their activity and prevent inefficient management. Using small-business data for Japan, we empirically investigate the relationship between firm performance and leverage. We find, first, that highly leveraged small businesses increase their trade payables less even if they have investment opportunities. Second, highly leveraged small businesses convert more bills receivables into cash by selling them to finance companies to finance their growth opportunities. Third, highly leveraged firms enjoy stronger performance (measured as firm sales growth or profitability) compared with low-leveraged firms. These results highlight the benefits of high leverage for small businesses.
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Notes
Caneghem and Campenhout (2012) showed that the quality of financial statements increases borrower’s leverage.
Switzerland has the highest ratio, while Hong Kong has the second highest.
See http://www.crd-office.net/CRD/english/ (last accessed: April 2014) for information about the CRD.
According to the 2005 White Paper on Small and Medium Enterprises in Japan, “Under the Small and Medium Enterprise Basic Law, the term ‘small and medium enterprise’ (SME) refers in general to enterprises with capital stock of not in excess of ¥300 million or 300 or fewer regular employees, and sole proprietorships with 300 or fewer employees.”…“Small enterprises” are defined as enterprises with 20 or fewer employees.”(p. viii) See http://www.chusho.meti.go.jp/pamflet/hakusyo/h17/download/2005hakusho_eng (last accessed: April 2014).
According to Sakai et al. (2010), the CRD covered about 60 % of small incorporated firms in Japan in 2001. As we limit our analysis to firms that existed for more than four consecutive years in the CRD, the sample size in our paper is smaller than the full sample collected in the CRD.
The industry-adjusted operating income ratio is defined as the ratio of operating income to total assets, calculated by subtracting the mean value in the medium category in the industrial classification averaged for 2 years from year \(t\) to \(t+1\). Industry-adjusted sales growth is defined as the growth rate of sales for 2 years from \(t-1\) to \(t+1\) \(([\hbox {sales}_{t+1}-\hbox {sales}_{t-1}]/\hbox {assets}_{t-1})\), calculated by subtracting the mean value in the medium category in the industrial classification. The industry-adjusted operating income growth is defined as the growth rate of operating incomes for 2 years from \(t-1\) to \(t+1\) \(([\hbox {operating\,incomes}_{t+1} - \hbox {operating\,incomes}_{t-1}]/\hbox {assets}_{t-1})\), calculated by subtracting the mean value in the medium category in the industrial classification.
According to Klapper (2006), factoring is “a type of supplier financing in which firms sell their creditworthy accounts receivable at a discount (generally equal to interest plus service fees) and receive immediate cash.” (pp. 3111–3112). See Klapper (2006) for a detailed discussion about factoring.
See Matsumura and Ryser (1995) for details about bill discounting in Japan.
See pp. 79–80 in “Hacchu hoshikitou torihikijyouken kaizenchousa jigyouhoukokusho 2011 (Study to improve trading conditions such as ordering systems)”, downloaded from http://www.meti.go.jp/meti_lib/report/2012fy/E002152 (last accessed: April 2014).
See the article “Tegata waribiki ni tokka shite shikin choutatsu wo shien” (Support for bills discounting in business finance), pp. 66–67, Turnaround PARTNERS GUIDE 2012.
Following previous studies, we use the independent variables from \(t-1\) to \(t+1\). The results are similar if we use the independent variables from \(t\) to \(t+1\).
If creditors acknowledge the positive NPV of projects (not the burden of debts), they offer credit for highly leveraged firms with greater investment opportunities. If this effect is strong, the coefficients of \({\text{Leverage}}_{{i,t - 2}} \times {\text{Investment}}\;{\text{Opportunities}}_{{{\text{i}},t{\text{ - 1}} \to t{\text{ + 1}}}}\) should be positive. The reason is that the negative effects of \(\text{Leverage}_{i,t-2}\) are weakened when firms have greater investment opportunities.
The business DI is available on the Web site of the Bank of Japan (last accessed: April 2014) (http://www.boj.or.jp/en/statistics/tk/gaiyo/2001/index.htm/).
In previous studies using data on listed firms, the level of investment opportunities is measured by the market-to-book ratio or Tobin’s Q. In our studies using data on non-listed firms, the market-to-book ratio and Tobin’s Q are unavailable.
http://www.boj.or.jp/en/statistics/outline/exp/tk/extk.htm/#01 (last accessed: April 2014).
When the sales of firms are zero, we set the value of this variable equal to 1.
For example, Kang and Stulz (2000) specified stock returns as a proxy for firm performance in considering listed firms.
From a textbook point of view, the objective of firms is to maximize profits. However, an increase in sales is not always consistent with profit maximization. Despite this, many previous studies (for example, Opler and Titman 1994; Molina and Preve 2012) have used real growth in total sales as a proxy for firm performance.
Industry-adjusted (tangible fixed) assets growth is calculated as (tangible fixed) assets growth calculated by subtracting the mean value in the medium category in the industrial classification.
The results are similar if we specify the industry-adjusted ordinary income ratio as the proxy for firm performance (results are not shown in the table). Ordinary income includes net financial income and expenses. Therefore, this measure of income is naturally lower when interest payments are large. However, our results do not indicate that highly leveraged firms make large interest payments.
We define the ratio of truncated firms in year \(t\) as 1—(number of existing firms in year \(t\)/number of existing firms in year \(t-1\)). The ratio of the truncated samples is 12.87 % across all samples.
We use the food industry as a benchmark.
Ongena and Smith (2001) showed that sales, age, profitability, Tobin’s Q, and leverage affect the duration of bank–firm relationships. To estimate the selection variable, we include these variables, except for Tobin’s Q, as it is unavailable.
See http://www.fsa.go.jp/manual/manualj/yokin (in Japanese) (last accessed: April 2014) for more detail.
See the website of Tokyo Stock Exchange: http://www.tse.or.jp/english/rules/delisting/summary/index.html. (last accessed: April 2014).
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Acknowledgments
The author is a researcher at the CRD Association, which has given permission for the use of its data. The views expressed in this paper do not necessarily reflect those of the CRD Association. This study is supported by a Grant-in-Aid for Young Scientists (B) from the Japan Society for the Promotion of Science. The author would like to thank the Editor (Stephan Heblich) and two anonymous referees for their many useful comments and suggestions. The author would also like to thank Yuichi Abiko, Yasuhiro Arikawa, Takashi Hatakeda, Nobuhiko Hibara, Sumio Hirose, Kaoru Hosono, Hideaki Miyajima, Daisuke Miyakawa, Arito Ono, Kenta Toyofuku, Yoshiro Tsutsui, Hirofumi Uchida, Iichiro Uesugi, Wako Watanabe, Peng Xu, Fukuju Yamazaki, Noriyuki Yanagawa, and Yukihiro Yasuda for many valuable comments. The seminar participants at GRIPS, Hosei University, RIETI, Osaka University, Waseda University, and Nihon University also provided useful comments. An earlier version of this paper is entitled “How Do Small Businesses Mitigate the Cost of Financial Distress?”. All remaining errors are mine.
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Tsuruta, D. Leverage and firm performance of small businesses: evidence from Japan. Small Bus Econ 44, 385–410 (2015). https://doi.org/10.1007/s11187-014-9601-5
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DOI: https://doi.org/10.1007/s11187-014-9601-5