Advertisement

Small Business Economics

, Volume 31, Issue 2, pp 117–136 | Cite as

Testing trade-off and pecking order theories financing SMEs

  • José López-Gracia
  • Francisco Sogorb-MiraEmail author
Article

Abstract

This paper explores two of the most important theories behind financial policy in Small- and Medium-Sized Enterprises (SMEs), namely, the pecking order and the trade-off theories. Panel data methodology is used to test empirical hypotheses on a sample of 3,569 Spanish SMEs over a 10-year period dating from 1995 to 2004. Results suggest that both theoretical models help to explain SME capital structure. However, despite finding clear evidence that SMEs follow a funding source hierarchy (pecking order model), our results reveal that greater trust is placed in SMEs that aim to reach target or optimum leverage (trade-off model). This remains true even when SMEs take a long time to reach this level, due to the high transaction costs they have to face. Non-debt tax shields (NDTS), growth opportunities and internal resources all seem to play an important role in determining SME capital structure. Both size and age are also found to be significant factors. Moreover, the empirical evidence obtained confirms that SMEs clearly behave differently to large firms where financing is concerned.

Keywords

Pecking order Trade-off Capital structure Small- and Medium-Sized Enterprises 

JEL Classifications

G32 C33 L26 

Notes

Acknowledgements

The authors are grateful for comments and suggestions concerning earlier drafts from Alejandro Casino, Amado Peiró, Juan Sánchis and two anonymous referees at the Small Business Economics: An International Journal.

References

  1. Anderson, T. W., & Hsiao, C. (1982). Formulation and estimation of dynamic models using panel data. Journal of Econometrics, 18, 47–82.CrossRefGoogle Scholar
  2. Ang, J. S. (1976). The intertemporal behavior of corporate debt policy. Journal of Financial and Quantitative Analysis, 11, 555–566.CrossRefGoogle Scholar
  3. Ang, J. S. (1992). On the theory of finance for privately held firms. The Journal of Small Business Finance, 1(3), 185–203.Google Scholar
  4. Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58, 277–297.CrossRefGoogle Scholar
  5. Aybar Arias, C., Casino Martínez, A., & López Gracia, J. (2004). Efectos financieros y estratégicos sobre la estructura de capital de la pequeña y mediana empresa. Moneda y Crédito, 219, 71–98.Google Scholar
  6. Baltagi, B. H. (1995). Econometric analysis of panel data. New York: John Wiley & Sons.Google Scholar
  7. Barclay, M. J., Smith, C., & Watts, R. (1995). The determinants of corporate leverage and dividend policies. Journal of Applied Corporate Finance, 7, 4–19.CrossRefGoogle Scholar
  8. Barton, S. L., Hill, N. C., & Sundaram, S. (1989). An empirical test of stakeholder theory predictions of capital structure. Financial Management, 18(1), 36–44.CrossRefGoogle Scholar
  9. Berger, A. N., & Udell, G. F. (1998). The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle. Journal of Banking and Finance, 22, 613–673.CrossRefGoogle Scholar
  10. Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87, 115–143.CrossRefGoogle Scholar
  11. Bradley, M., Jarrell, G. A., & Kim, E. H. (1984). On the existence of an optimal capital structure: theory and evidence. The Journal of Finance, 39(3), 857–878.CrossRefGoogle Scholar
  12. Chittenden, F., Hall, G., & Hutchinson, P. (1996). Small firm growth, access to capital markets and financial structure: Review of issues and an empirical investigation. Small Business Economics, 8, 59–67.CrossRefGoogle Scholar
  13. Cosh, A. D., & Hughes, A. (1994). Size, financial structure and profitability. In A. Hughes, & D. J. Storey (Eds.), Finance and the small firm. London: Routledge.Google Scholar
  14. Dammon, R. M., & Senbet, L. W. (1988). The effect of taxes and depreciation on corporate investment and financial leverage. The Journal of Finance, 43(2), 353–373.CrossRefGoogle Scholar
  15. DeAngelo, H., & Masulis, R. W. (1980). Optimal capital structure under corporate and personal taxation. Journal of Financial Economics, 8, 3–29.CrossRefGoogle Scholar
  16. Donaldson, G. (1961). Corporate debt capacity: A study of corporate debt policy and the determination of corporate debt capacity. Boston: Graduate School of Business, Harvard University Press.Google Scholar
  17. Drobetz, W., & Wanzenried, G. (2006). What determines the speed of adjustment to the target capital structure. Applied Financial Economics, 16, 941–958.CrossRefGoogle Scholar
  18. Fama, E. F., & French, K. R. (2002). Testing trade-off and pecking order predictions about dividends and debt. The Review of Financial Studies, 15(1), 1–33.CrossRefGoogle Scholar
  19. Frank, M., & Goyal, V. (2003). Testing the pecking order theory of capital structure. Journal of Financial Economics, 67, 217–248.CrossRefGoogle Scholar
  20. Frank, M., & Goyal, V. (2005). Trade-off and pecking order theories of debt. In B. Eckbo (Ed.), Handbook of corporate finance: empirical corporate finance. Handbooks in finance series. North Holland: Elsevier.Google Scholar
  21. Graham, J. R. (1996). Debt and the marginal tax rate. Journal of Financial Economics, 41, 41–73.CrossRefGoogle Scholar
  22. Haugen, R. A., & Senbet, L. W. (1986). Corporate finance and taxes: A review. Financial Management, 15(3), 5–21.CrossRefGoogle Scholar
  23. Hennessy, C. A., & Whited, T. M. (2005). Debt dynamics. The Journal of Finance, 60(3), 1129–1165.CrossRefGoogle Scholar
  24. Jalilvand, A., & Harris, R. S. (1984). Corporate behavior in adjusting to capital structure and dividend targets: An econometric study. The Journal of Finance, 39(1), 127–145.CrossRefGoogle Scholar
  25. Jensen, G., Solberg, D., & Zorn, T. (1992). Simultaneous determination of insider ownership, debt and dividend policies. Journal of Financial and Quantitative Analysis, 27, 247–261.CrossRefGoogle Scholar
  26. Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review, 76(2), 323–329.Google Scholar
  27. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3, 305–360.CrossRefGoogle Scholar
  28. Jordan, J., Lowe, J., & Taylor, P. (1998). Strategy and financial policy in UK small firms. Journal of Business Finance & Accounting, 25(1&2), 1–27.CrossRefGoogle Scholar
  29. Kim, E. H. (1978). A mean-variance theory of optimal capital structure and corporate debt capacity. The Journal of Finance, 33(1), 45–63.CrossRefGoogle Scholar
  30. Kraus, A., & Litzenberger, R. H. (1973). A state-preference model of optimal financial leverage. The Journal of Finance, 28(4), 911–922.CrossRefGoogle Scholar
  31. Leary, M. T., & Roberts, M. R. (2005). Do firms rebalance their capital structures?. The Journal of Finance, 60(6), 2575–2619.CrossRefGoogle Scholar
  32. Mackie-Mason, J. K. (1990). Do taxes affect corporate financing decisions? The Journal of Finance, 45(5), 1471–1493.CrossRefGoogle Scholar
  33. Michaelas, N., Chittenden, F., & Poutziouris, P. (1999). Financial policy and capital structure choice in UK SME: Empirical evidence from company panel data. Small Business Economics, 12, 113–130.CrossRefGoogle Scholar
  34. Miguel, A. de, & Pindado, J. (2001). Determinants of capital structure: New evidence from Spanish panel data. Journal of Corporate Finance, 7, 77–99.CrossRefGoogle Scholar
  35. Modigliani, F., & Miller, M. H. (1963). Corporate income taxes and the cost of capital: A correction. The American Economic Review, 53(2), 433–443.Google Scholar
  36. Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5, 147–175.CrossRefGoogle Scholar
  37. Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 575–592.CrossRefGoogle Scholar
  38. Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13, 187–221.CrossRefGoogle Scholar
  39. Nerlove, M. (1958). Distributed and demand analysis for agricultural and other commodities. Agricultural Hand Book No 141. US Department of Agriculture.Google Scholar
  40. Ozkan, A. (2001). Determinants of capital structure and adjustment to long run target: Evidence from UK company panel data. Journal of Business Finance and Accounting, 28(1 & 2), 175–198.CrossRefGoogle Scholar
  41. Petersen, M. A., & Rajan, R. G. (1994). The benefits of lending relationships: Evidence from small business data. The Journal of Finance, 49(1), 3–37.CrossRefGoogle Scholar
  42. Rajan, R. G., & Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. The Journal of Finance, 50(5), 1421–1460.CrossRefGoogle Scholar
  43. Scherr, F. C., & Hulburt, H. M. (2001). The debt maturity structure of small firms. Financial Management, 30, 85–111.CrossRefGoogle Scholar
  44. Shyam-Sunder, L., & Myers, S. C. (1999). Testing static trade-off against pecking order models of capital structure. Journal of Financial Economics, 51, 219–244.CrossRefGoogle Scholar
  45. Sogorb-Mira, F. (2005). How SME uniqueness affects capital structure: Evidence from a 1994–1998 Spanish data panel. Small Business Economics, 25, 447–457.CrossRefGoogle Scholar
  46. StataCorp. (2005). Stata statistical software: Release 9. College Station: StataCorp LP.Google Scholar
  47. Stulz, R. M. (1990). Managerial discretion and optimal financing policies. Journal of Financial Economics, 26, 3–27.CrossRefGoogle Scholar
  48. Titman, S., & Wessels, R. (1988). The determinants of capital structure choice. The Journal of Finance, 43(1), 1–19.CrossRefGoogle Scholar
  49. Van der Wijst, N., & Thurik, R. (1993). Determinants of small firm ratio: An analysis of retail panel data. Small Business Economics, 5, 55–65.CrossRefGoogle Scholar
  50. Wald, J. K. (1999). How firm characteristics affect capital structure: An international comparison. The Journal of Financial Research, 22(2), 161–187.Google Scholar
  51. Wooldridge, J. M. (2007). Econometric analysis of cross section and panel data. Cambridge: The MIT Press.Google Scholar
  52. Zingales, L. (2000). In search of new foundations. The Journal of Finance, 55(4), 1623–1653.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC. 2008

Authors and Affiliations

  1. 1.Facultad de EconomíaUniversitat de ValènciaValenciaSpain
  2. 2.Departamento de Economía y EmpresaUniversidad CEU Cardenal HerreraElcheSpain

Personalised recommendations