Determinants of the capital structure of small and medium sized Brazilian enterprises.
| Autor | Forte, Denis |
| Cargo | Report |
Introduction
For the most part, the empirical capital structure literature investigates the behavior of stock market-listed companies to test the extent to which capital structure theories explain the cross-section of financing decisions. Therefore, these studies ignore the peculiarities of private small and medium enterprises (SMEs), which represent the majority of firms and account for the largest part of the gross domestic product (GDP) and employment of most countries. To address this gap we use a unique database provided by Serasa Experian that includes over 19,000 SMEs, representing a variety of business segments based in the state of Sao Paulo, a state that accounts for approximately 40% of the Brazil's GDP. We collected several financial indicators for these firms from 1994 through 2006. Though many firms had incomplete data, after removing the potential outliers, we were able to use more firm-year observations than most previous empirical corporate finance studies that use either SMEs or listed companies.
This research contributes to the capital structure literature in the following ways. First, we review the still incipient and fragmented literature that focuses on the capital structure decisions of SMEs in several countries and find two main research approaches: one based on questionnaires, surveys and interviews and another that uses secondary databases. Two tables show the variables, methods and results of these efforts in chronological order. Second, to our knowledge, we perform the largest empirical investigation of the determinants of the capital structure of privately owned SMEs in an emerging market and one of the largest investigations in the world, using a unique panel dataset to examine the cross-sectional and time-series variation in the leverage ratios of SMEs. Third, we estimate the empirical models by employing an econometric procedure that is more sophisticated than those used in most previous SME research--the System Generalized Method of Moments estimator (GMM-Sys) dynamic panel estimator (Blundell & Bond, 1998). The GMM-Sys procedure allows us to explore the panel structure of our dataset to address important and frequently ignored methodological concerns that are common to corporate finance studies, such as dynamic endogeneity (see Wintoki, Linck, & Netter, 2012).
The empirical analysis strongly suggests that the more profitable firms tend to be less financially levered. The estimated coefficients for our profitability proxies are both statistically and economically significant, which is compatible with pecking order arguments; i.e., when deciding how to finance their activities, firms favor internally generated resources over outside capital, either debt or equity. Additionally, we find that after controlling for profitability and other firm characteristics, asset growth is positively related to debt financing, implying that SMEs tend to finance their expansion with debt when internally generated funds are insufficient, which again is compatible with the pecking order theory. Additionally, we find weaker evidence that larger firms have more debt capacity, as predicted by traditional capital structure theories and that older SMEs are more conservative and tend to use less debt, although the magnitude of the coefficient is small in both cases. Finally, in some regressions, the coefficient for our risk proxy (rolling five-year standard deviation of the profitability ratio) is negative and statistically significant, as predicted by traditional trade-off theories.
The panel structure of our data also allows us to examine the dynamic behavior of leverage ratios. We find that leverage is highly persistent and that lagged leverage is the best predictor of subsequent leverage, consistent with the extant empirical literature. Interpreting our estimates in the context of partial adjustment models (see Oztekin & Flannery, 2012), we find annual speed of adjustment coefficients ranging from 20.4% to 34.1%. These estimates suggest that SMEs may periodically adjust their leverage ratios towards their target (or optimal) leverage but do so at a low speed. Recent empirical studies report similar results (Aybar-Arias, Casino-Martinez, & Lopez-Gracia, 2012; Oztekin & Flannery, 2012).
The remainder of the paper is organized as follows: second section reviews the literature on capital structure theories and their application to small and medium enterprises (SMEs); third section describes the data and the empirical strategy; fourth section presents the results; and final section concludes the paper.
Literature Review--Capital Structure and SMEs
Since the 1950s, capital structure has developed into one of the most productive and controversial research areas in the field of corporate finance, spawning a multitude of theoretical and empirical studies. Modigliani and Miller (1958) set the stage for subsequent research by proposing that financing choices are irrelevant in perfect markets. Later theoretical contributions argued that in a more realistic setting, firms could maximize market value by using the tax benefits associated with debt financing before excessively increasing their expected bankruptcy costs. The related theories that focus on the various costs and benefits of debt and equity financing became known as trade-off approaches (Harris & Raviv, 1991).
Jensen and Meckling (1976) reinterpreted the capital structure decision puzzle by considering that employees are hired to pursue the objectives of the owners of the firm, but they are actually biased towards the preservation of their own interests. Since then, a behavioral component known as agency cost was introduced in the capital structure equation. This conflict of interest problem was reinforced by Leland and Pyle (1977), who unveiled the information asymmetries between managers and investors in the process of valuing companies. Myers and Majluf (1984) later advanced a related theory, known as the pecking order theory, stating that information asymmetries would lead firms to always prefer to finance their activities with internally generated funds, followed by debt issuance, and would choose to issue new equity only as a last resort.
More recently, Baker and Wurgler (2002) proposed a theory founded in the exploitation of capital market inefficiencies by firm managers, in which a company would tend to issue new shares whenever the difference between its accounting value and its market value became sufficiently favorable. This third major line of capital structure research was called Equity Market Timing.
The empirical research in this field has also been vast and diverse. In a seminal paper, Titman and Wessels (1988) used firm-level accounting and market data to find that asset structure, non-debt tax shields, growth, singularity, industrial classification, size, profit volatility and profitability were potential determinants of U.S. companies' financing decisions. Later studies addressed other empirical issues, such as the dynamic behavior of leverage ratios, using panel data and more sophisticated estimation procedures. For example, Ozkan (2001) and Gaud, Jani, Hoesli and Bender (2005) suggested that listed companies partially adjust their leverage ratios towards a target (supposedly optimal or value-maximizing) ratio, as predicted by the trade-off approaches.
Notwithstanding the diversity of the capital structure literature, relatively few authors have investigated the financing decisions of small and medium enterprises. One possible reason for this limitation is that SME data are often scarce and sometimes unreliable because these firms, which are typically privately owned, are not required to disclose detailed information or have their reports audited. In addition, it has often been assumed that privately owned SMEs will eventually become publicly traded companies, though relatively few firms list their shares on a stock exchange or issue any publicly traded security throughout their life cycle.
Small and medium enterprises are responsible for a significant portion of the economic growth and employment in most countries. Because of the specificities and the life cycle of SMEs, they tend to be privately held and to employ less sophisticated accounting and financial practices than their larger counterparts. In fact, Katz and Cabezuelo (as cited in Gartner, Shaver, Carter, & Reynolds, 2004) report that many start-up companies have financial problems such as inadequate capitalization, excessive debt, and poor record keeping, and they relate these common problems to the poor financial education of entrepreneurs and, consequently, of the company.
Because of this data scarcity, investigators have often resorted to qualitative research designs. In a few cases, however, SME databases have been made available by official or private data providers, allowing researchers to perform statistical analyses using large samples. One example of the latter approach is the work by Kremp, Sauve and Paranque (1999), which was part of a joint project between Deutsche Bundesbank and the Banque de France to describe the asset and liability structure of manufacturing firms incorporated in Germany and France and investigate the monetary transmission mechanisms in the European Monetary Union. The authors constructed balanced panels with 15,000 French firms and over 9,000 German firms observed between 1987 and 1996 and between 1987 and 1995, respectively.
In the following tables, we briefly describe selected empirical works in this still incipient field, presented in chronological order. The studies that used secondary data are described in Table 1. Table 2 presents the studies that gathered primary data (via questionnaires, surveys and interviews).
Method and Data Description
The extant capital structure research using SMEs lacks homogeneity in terms of the methodological procedures utilized, partly as a consequence of the difficulty of obtaining...
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