Research Methodology and Profile of Respondents: Appendix A

Appendix A
Research Methodology and Profile

of Respondents
Survey data are more or less the only alternative if you want to have data on attitudes,
perceptions, strategies, and resources from a large number of cases
(Davidsson and Wilkund 2000, p. 27)
A.1 Introduction
The research design implemented in conducting this study is outlined and explained
in this appendix, and a detailed profile of respondent firms is presented. This
information is important for providing an explanation for the methodology selected,
as well as contextualising results and conclusions. This appendix is structured as
follows; firstly, a comprehensive account of important methodological issues is
provided by describing the research design employed, as well as selection of the
sample frame. In the following section, the process of designing, improving, and
piloting the survey instrument is detailed, along with the data collection process.
Secondly, respondent firms are described in detail. Firm characteristic data presented
includes age, size, sectoral composition, expenditure on research and development,
and export activity. Data is presented in tabular form throughout the appendix.
Supplementary tables, primarily documenting sectoral differences, are provided at
the end of the appendix, and are labelled as Tables A.9, A.10, A.11, and so forth.
A.2 Data Collection
The most important consideration when choosing a research design is its appropriate-
ness to the research question posed, referred to as “. . . the dictatorship of the research
question (not the paradigm or method)” by Tashakkori and Teddlie (1998, p. 20). This
study investigates the financing of SMEs, and the subject is addressed by considering
a number of specific issues. Three questions are posed; (a) Do sources of finance
117
118 Appendix A Research Methodology and Profile of Respondents
employed by SMEs change across age profiles?; (b) Are sources of finance employed
by SMEs determined by firm characteristics?; and (c) What are firm owners’ goals
and preferences when considering the financing decision?. These research questions
investigate SME financing on two levels of analysis, and require firm characteristic
data, as well as information on financing preferences and objectives of firm owners.
Firm financing is analysed across a life cycle continuum, and data required to conduct
this research is not publicly available. There are difficulties with secondary databases,
such as exist, as explained in the following section. Furthermore, information on the
motivations, business goals, and financing preferences of SME owners is difficult to
obtain by means other than primary data collection.
A consideration for SME researchers is the paucity of secondary sources of data
on SME resourcing, which requires them to engage in primary research to compile
this information. For example, researchers in the US and the UK employ detailed
survey instruments to compile databases on the financing of SMEs by conducting
the National Survey of Small Business Finances (NSSBF) and the United Kingdom
Survey of Small and Medium-sized Enterprises’ Finances (UKSMEF) respectively.
Although secondary sources such as NSSBF data contain a large number of obser-
vations, they suffer from a degree of coverage error. For example, the NSSBF is
representative of approximately 5 million nonfirm, for profit, nonfinancial SMEs
with less than 500 employees. Whilst data generated by these cross-sectional studies
is not perfect for conducting longitudinal analysis, they provide researchers with a
large volume of observations on which to conduct detailed statistical analysis.
In keeping with the positivist epistemological orientation of this study, and
in common with data collection methods employed in previous studies, a self-
administered questionnaire survey was employed to collect data. The primary
advantage of the methodology employed is that it facilitates collection of data
unavailable from any other source, and facilitates collection of information required
to answer specific research questions. Additional benefits of using surveys are:
. . ...[that they] can be used to (1) test some of the qualitative assumptions and conclusions
in the capital structure literature, and (2) indicate practitioners’ perceptions when making
capital structure choices
(Norton 1991, p. 162).
Use of a questionnaire survey instrument was therefore deemed the most appro-
priate method of data collection for this study. Requesting uniform data from
respondents, this methodology facilitates comparative statistical analysis. Addition-
ally, questionnaire surveys are a relatively cheap and efficient means of data collec-
tion, and enabled the research to be completed within time and resource constraints.
A.3 Selection of the Sample Frame
Survey research is conducted to estimate the distribution of characteristics in a

population within defined confidence limits (Dillman 2007). Generalisability of
results of a survey study is therefore dependent on the use of a representative
A.3 Selection of the Sample Frame 119
sample from the total population. One of the greatest challenges in conducting
survey research on the SME sector is the well documented non-availability of total
population listings. Previous researchers in many countries have highlighted the
lack up-to-date complete population lists of SMEs, notwithstanding the difficulty in
maintaining these lists because of frequent changes due to many new entrants, and a
substantial number of SMEs ceasing to trade within 3 years of start-up (Cressy
2006b). Researchers endeavour to overcome lack of total population listings in a
number of ways. Previous researchers have selected samples employing a variety of
sources: (1) by compiling their own list from a number of directories (Hogan 2004),
(2) by employing a list from one source; for example, a list of the occupants of a
business or science park (Westhead and Storey 1997, Ullah and Taylor 2005), (3)
By employing commercially available lists, such as the Dun and Bradstreet data-
base used by Hall et al. (2004), (4) By employing listings from government
development agencies (Kinsella et al. 1994), (5) By employing data from commer-
cial banks (Audretsch and Elston 1997), and (6) By surveying or interviewing firms
on the basis of accessibility (Howorth 2001). A common difficulty with each of
these sample frames is that they are not representative in the true sense, as they are
not random samples drawn from complete national populations. These samples are
typically confined to a geographical area or an industry sector. Of course, research-
ers are upfront about this and most studies explicitly state that they are not
representative of the total SME population in the countries surveyed.
Curran and Blackburn (2001, p. 60) note that “. . . there is no single publicly
accessible register of businesses in the UK”, which is also true in the Irish case.
Consequently, it is difficult to obtain a random or probability sample in the strict
quantitative sense. When considering a sample frame of SMEs on which to conduct
a questionnaire survey, a number of sources can be investigated. Perhaps the most
complete listing of the total business population may be obtained from the Value
Added Tax (VAT) register of the office of the revenue commissioners. This register
includes persons supplying goods or services within the state if their turnover is
above certain limits (over €35,000 for those supplying services, and €70,000 for
those supplying goods). Although this register details the number of enterprises
registered by sector, there are difficulties with using this listing because it includes
entities that may never have traded, or individuals who have registered for purposes
other than engaging in business.
Another source of information is the Companies Registration Office (CRO),
which is the statutory authority for registering all new companies in the Republic of
Ireland. It is the central repository of public information on Irish companies,
maintaining a database on all incorporated firms in the state, and all companies
are obliged to file accounts yearly. Some of this data is freely available, and other
information is accessible on payment of a fee. Whilst the database of CRO
companies may be a reasonably accurate listing of all incorporated firms in the
state, a number of features of these records make them unsuitable for academic
research. Firstly, the database is not up-to-date and contains a number of firms that
have ceased trading. Additionally, accounts for recent years are typically not
available, with some firms not having filed accounts for 5 years or more. Secondly,
accounting information provided in a number of cases is limited, as some firms are

only obliged to provide an abridged balance sheet. The database is thus not
consistent in terms of accounting information supplied. Thirdly, non incorporated
firms are excluded from this database.
National development agencies Enterprise Ireland (EI), the Industrial Develop-
ment Authority (IDA), the Shannon Free Airport Development Company
(SFADCo), Údarás na Gaeltachta, and county enterprise boards maintain a list of
client companies, although this information is not publicly available because
agencies insist on maintaining confidentiality. For example, Enterprise Ireland
cite inability to decouple contact details of companies from confidential financial
information, and so do not release details of these firms. Another potential source of
information is the Central Statistics Office (CSO), which conducts censuses at
various intervals, such as the Census of Agriculture, Census of Building and
Construction, the Information and Communications (ICT) survey, the annual Ser-
vices Enquiry, and the annual Census of Industrial Enterprises (conducted regularly
since 1975). The latter two are the most comprehensive, including firms with more
than three employees, and providing analysis of enterprises by size and sector.
These censuses are valuable for providing important structural data on two sectors,
although information on specific firms is not available from the CSO as they
emphasise confidentiality of data supplied by respondents.
Yet another potential source of information on SMEs are member lists main-
tained by SME organisations such as the Irish Small and Medium Sized Enterprises
Association (ISME), the Small Firms Association (SFA), and Plato Ireland Limited.
These lists are not representative of the Irish SME population, however, as they
“suffer” from self selection, and they have size and sectoral biases. For example, the
Plato Ireland organisation is concentrated in seven geographical regions, and
member firms typically have between 3 and 50 employees.
Commercially available databases may be sourced from companies such as Dun
and Bradstreet. The latter database contains detailed accounting data on selected
companies, and has been employed in previous empirical studies of SME financing
(Hall et al. 2004). Use of this listing to extract a representative sample of SMEs on
which to distribute a questionnaire instrument has a number of drawbacks, how-
ever, primarily because it does not include the total population of SMEs. Similar to
listings from other sources, firms no longer trading may remain on the Dun and
Bradstreet database. New firms may not have been entered on the database if there
have been no requests for credit information about the business (Curran and
Blackburn 2001). In common with other commercially held databases, smaller,
newer firms are thus most likely to be underrepresented on the Dun and Bradstreet
listing.
Considering the issues outlined above, and the level of resources available, the
sample frame selected for this study is based on non-probability sampling. The
sample frame employed is the Business World “Next 1,500” list of firms. This list is
compiled from a number of sources, including CRO data, print and internet media
sources, the National Directory Database (NDD), and is maintained and updated
once a year by Business World. This firm compiles a list of the “Top 1,000” firms
A.4 Development of the Questionnaire Instrument 121
annually, measured by turnover. A list of the “Next 1,500” is also compiled

annually, based on firms with at least 20 employees. The “Next 1,500” listing
provides contact details of each firm; classification by NACE code; names and
contact details of a number of officers, including the managing director, financial
controller, IT, personnel, operations, marketing, quality and health and safety
managers; and in a number of cases the number of employees. It is readily
acknowledged that this list is not representative of the total Irish SME population,
and it contains predominantly medium sized firms as defined by the European
Commission (2003). Micro enterprises and small firms with between 10 and 20
employees are not represented in the listing. Firms on the “Next 1,500” list thus
represent a sample of successful, surviving, medium sized firms that have a
minimum of 20 employees, which is similar to the profile of Irish firms in Storey
and Johnson (1987). (In other countries, such as the US for example, these firms
might be considered SMEs, rather than medium sized). Unlike sample frames
employed in a number of previous studies, this listing does not suffer from sectoral
or regional bias, as the sample selected is not confined to particular sectors or
geographical regions. It is difficult to confirm representativeness of the sample by
sector, although in the case of firms in services and industrial production sectors
an approximate estimate may be ascertained by comparison with CSO annual
censuses. Use of this sample frame means that the study is subject to survivorship
bias, as non-surviving firms are not included.
The sample frame contains 1,503 firms in total. This list was substantially
“cleaned” and refined to obtain a list of firms consistent with the aims of the
study, i.e. independent, non-financial firms, within the parameters of the European
Commission (2003) definition of an SME. Subsidiaries of multinational and
national parent companies were removed from the total sample frame, numbering
578 and 195 firms respectively. This data highlights a distinctive feature of the Irish
industrial structure, i.e. the presence of a large number of multinational companies.
13 banking and finance firms were excluded, and 15 firms were no longer at the
given address or had gone out of business. Some of this information was included in
the database, and the remainder was gleaned in the course of data collection. The
“cleaned” database included 702 firms in total, and this information is summarised
in Table A.1.
A.4 Development of the Questionnaire Instrument
Data for this study was collected by means of a self-administered questionnaire

instrument. A number of appropriate questions were immediately apparent in
variables required to answer the research questions posed. The remaining questions
were generated to collect data to test propositions formulated from theoretical and
empirical literature. In formulating and developing questions for the survey instru-
ment, questionnaires previously designed by researchers in conducting capital
structure investigations were consulted and considered. These included survey
Table A.1 Database detail and survey response rate

Number of firms
Sample size 1,503
Ineligibles:
Banking and finance firms 13
Subsidiary – multinational parent (includes takeovers) 578
Subsidiary – Irish parent 195
No longer at this address/no longer in business 15
Total ineligible 801
Total eligible 702
Valid/useable returns 299
Response rate (%) 42.6
instruments employed in corporate finance research (Norton 1991; Graham and

Harvey 2001), and instruments designed for studies in the SME sector (Cressy and
Olofsson 1997b; Michaelas et al. 1998; Hogan 2004). Additionally, questions
employed in previous papers were replicated where appropriate (Cooley and
Edwards 1983; LeCornu et al. 1996). The advantage of consulting previous survey
instruments and adopting questions posed in previous studies when creating a
questionnaire is that questions have undergone cognitive testing, and are less
susceptible to misinterpretation or misconstruction. Additionally, there may be
useful comparative elements between studies.
In designing questions to elicit sensitive financial information and capital struc-
ture data, account was taken of the findings of Ang (1992) and Avery et al. (1998)
regarding interconnection of firm owners’ income with firm financing. Consider-
ation was also taken of experiences of researchers conducting regular survey
research on SME financing, such as that of Cox et al. (1989), who reported
difficulties in sourcing accurate financing data from respondents when compiling
the NSSBF. This problem is universal. For example, the Small Business Survey in
the UK reported that “. . .Unfortunately, some 29% of businesses could not, or
would not, provide information on turnover” (Small Business Service 2006, p. 4).
Because of the reluctance of firm owners to report this data, sources of financing
were requested in percentage rather than absolute form. Responses to this question
provided rich data, and have an advantage over questions posed in previous studies
which request mentions (Holmes and Kent 1991), or perceived importance (Cressy
and Olofsson 1997b) of the source of finance employed. Similar data was also
requested for the start-up stage of the firm. One disadvantage of requesting this data
is the potential for error, similar to that noted by Cox et al. (1989) when requesting
absolute amounts. Notwithstanding the potential for reporting error, requesting
percentage rather than absolute amounts proved successful in limiting non
response, as 92% of respondents provided usable replies to the “sources of
financing used at present” question.
Similarly mindful of respondents’ reluctance to report data pertaining to
financing, turnover information was requested separately in categorical form.
Further demographic information on respondents was collected in categorical
form and determined by; the European Commission (2003) definition (number of
A.5 Elements Incorporated to Improve Response Rate 123
employees); NACE codes (sector); or previous studies (age categories as used in

previous Industrial Development Authority (IDA) censuses). One of the goals of
this study is to investigate motivations, business goals, and preferences of the firm
owner in relation to the financing decision. The survey instrument contained
questions on financing preferences of the firm owner, as well as questions seeking
to ascertain the most important considerations when raising additional debt or
equity financing. Principal financial objectives of firm owners were sought, along
with views on funders and requirements of financiers. Questions were also
formulated seeking respondents’ views on the influence of the debt-tax shield,
timing, and signalling considerations on the financing decision. An alternative
means of investigating these theories is to test multivariate models employing
proxy variables, although it is difficult to make accurate deductions and predictions
based on proxies. Employing direct questions to investigate these issues has
advantages over testing their applicability using proxy variables, and highlights
an advantage of survey research in this regard.
When determining the order of questions, it was decided not to place questions
requesting sensitive information at the very beginning of the questionnaire. Ques-
tions requesting capital structure data were therefore contained on the third page of
the questionnaire, following questions requesting relatively less sensitive informa-
tion. “Demographic” information was requested on the final page, based on the
reasoning that respondents are likely to grow weary towards the end of the ques-
tionnaire, and this information is relatively easy to recall.
A.5 Elements Incorporated to Improve Response Rate
The cover page of the questionnaire instrument provided a description of the

purpose of the study, along with a request that the survey be completed by the
chief financial officer, or equivalent representative. The confidentiality of replies
was emphasised, and an average completion time (which emerged from the pilot
study) was suggested. Contact details of the researcher were also provided.
Empirical evidence from a number of studies indicates that university sponsor-
ship increases response rates (Fox et al. 1988; Faria and Dickinson 1992, 1996), and
so the ideogram of the universities of the researcher (Dublin City University) and
his supervisor (Trinity College Dublin) were emblazoned on the cover of the
questionnaire. Additionally, the ideogram of the researcher’s university was on
the cover letter and the return envelope supplied. Dillman (2000) states that this
adds prominence to the survey instrument, and helps recognition. This latter point is
particularly important, as a proportion of respondents are likely to be graduates of
business degrees delivered by either university. Dublin City University delivers one
of the most popular undergraduate accounting programmes in the country, a
qualification commonly held by chief financial officers in Irish SMEs.
The postal questionnaire was printed on coloured paper to enhance recognition,
and to distinguish it from the multitude of other postal questionnaires that SMEs
receive. Although previous studies report that use of coloured paper does not elicit a
higher response rate than white paper (Booth 2003; Newby et al. 2003), follow-up
telephone calls revealed that a number of respondents were able to locate the
questionnaire instruments on their desks amid a myriad of other paperwork because
of the distinctive colour. This is consistent with the “greater retrievability effect”
discovered by Nederhof (1988).
Dillman (2007) recommends inclusion of a return envelope to reduce inconve-
nience to respondents. Although empirical evidence indicates that use of postage
stamps on return envelopes, rather than business reply envelopes result in greater
response rates because they are seen as more personal (Armstrong and Lusk 1987;
Fox et al. 1988), respondents were supplied with a Freepost envelope in which to
return completed survey instruments as it was more efficient. Despite clear notifi-
cation of the prepaid return envelope, a number of respondents paid additional
postage on return envelopes.
Empirical evidence from previous studies indicates that monetary (Duncan
1979; Jobber et al. 2004) and nonmonetary (Willimack et al. 1995) incentives
increase the response rates and the speed of return (Nederhof 1983a) of question-
naire surveys. The reasoning behind provision of incentives is that they induce
greater participation by respondents, although the increase in response rate is
negligible when used in surveys with high base response rates (Nederhof 1983a,
p. 109). Taking account of the cost of providing monetary incentives (Jobber et al.
2004), it was decided to make a donation to charity for each completed survey
received. This inducement is similar to the one offered by Faria and Dickinson
(1992), who noted a positive effect on response rate and response speed.
Experts in survey research indicate that multimode approaches in survey deliv-
ery provide superior response rates to single mode approaches (Schaefer and
Dillman 1998). Simsek and Veiga (2001) outline the advantages of, and need for
increased use of internet surveys. Following the recommendation of Dillman
(2007), an internet version of the survey instrument was developed using the
SurveyMonkey.com website. Layout of the internet version of the questionnaire
was identical to the paper based version. Approximately 17% of respondents
availed of this mode of response, as shown in Table A.2.
An important issue in adopting a survey methodology for data collection is non-
response bias. Difficulties arise in aggregating results to the population of SMEs, as
the profile of respondents may be significantly different from non-respondents.
Non-response bias is commonly tested by comparing characteristics and data of
respondents with non-respondents. This test is not possible in the present study
because of anonymity of replies. Another means of testing for non-response bias is
Table A.2 Response rate by mode of delivery

Number of useable Percentage
responses of total
Postal returns 249 83
On-line returns 50 17
Total useable responses 299 100
A.6 Piloting and Testing the Questionnaire Instrument 125
to compare data of early respondents with that of late respondents, as Oppenheimer

(1966) contends that late respondents are expected to be more similar to non-
respondents. This test was conducted on the financing data and firm characteristics
of respondents. No material differences were found between early and late respon-
dents, suggesting no reason for concern about non-response bias in the data.
A.6 Piloting and Testing the Questionnaire Instrument
A preliminary version of the questionnaire instrument was circulated among aca-

demics specialising in areas of economics, statistics, research methods, SME
finance, marketing, and organisational behaviour. Feedback was requested on all
elements of the survey instrument, including data requested and implications for
analysis, cognitive aspects, layout and design, length of the survey instrument, and
the order of questions. Feedback was requested from international academic experts
in the field of SME finance, some of whom had experience in conducting survey
research, including Alan Cameron, Francis Chittenden, Teresa Hogan, Claire
Massey, David Storey and David Tweed. Valuable advice was also offered by
Brian Lucey and Tom Mc Cluskey who had conducted questionnaire based research
on Irish publicly quoted companies. Advice was also solicited from professionals
engaged in the supply of financial advice and expertise to SMEs, including the head
of life sciences at Enterprise Ireland (Lisa Vaughan), members of a county enter-
prise board, and the director of wealth management at an accounting/financial
management firm (Matt Hanley). Recommendations of these academic and profes-
sional experts were integrated into the survey instrument prior to its distribution for
a pilot survey.
Initially the research design envisaged testing the questionnaire instrument by
conducting a focus group of SME owners, thus incorporating their suggestions into
the final instrument. Over 60 firms were contacted and invited to take part in a focus
group. Whilst enthusiastic about the study, they declined the invitation to take part,
citing inconvenience and lack of time. This experience illustrates the difficulty in
conducting small business research employing focus groups, and mirrors the
experience of Blackburn and Stokes (2000), who report that it took over 100
approaches to recruit 8 participants for a focus group. A number of contactees
agreed to participate in a postal piloting of the survey instrument, and to suggest
improvements and amendments in a telephone follow-up.
The questionnaire was posted to ten firms for a pilot study. Postal replies were
received from two respondents, and all ten firms were telephoned to elicit feedback
on how the survey instrument should be improved and amended prior to distribution
to the sample frame. Suggestions and recommendations for improvement from all
ten respondents were incorporated into the completed questionnaire before it was
distributed to the sample. Additionally, participants in the pilot study were required
to record the time it took to complete the survey. The average completion time was
15 min. In lengthy telephone conversations, owners and chief financial officers of
firms selected for the pilot study were enthusiastic about the research, and forth-
coming and frank in their replies, indicating the salience of the research topic for
respondents. This has an important implication for the study, as Heberlein and
Baumgartner (1978) find that salience of the research topic is the principal deter-
minant of high response rates.
The method of administration selected was of multiple contacts as advised by
Dillman (2007), because previous studies indicate that multiple contacts greatly
increase response rate (Schaefer and Dillman 1998; Newby et al. 2003). Although
studies suggest that pre-notification has a positive impact on response rates (Fox
et al. 1988; Dillman 2007), it was decided not to pre-notify the sample in order to
keep intrusion on firms to a minimum. The sample was contacted four times as
detailed in Table A.3. The first contact was on Tuesday 3rd of May 2005, when a
questionnaire was addressed to a named chief financial officer in each company
listed on the database. In cases where the chief financial officer’s name was not
listed, the questionnaire was sent to the firm owner. The mailing contained the
questionnaire, a covering letter, and a return Freepost envelope. The covering letter
was personalised, as advised by Schaefer and Dillman (1998) and Dillman (2007).
It was printed on letterhead stationery and outlined the context of the study and
salience of the topic. Other exchange relationships were invoked (Dillman 2000),
and the covering letter indicated the practical implications of the survey findings for
respondents, particularly in relation to enterprise policy. The personalised covering
letter also detailed the Uniform Resource Identifier (URL) where the online version
of the survey instrument could be accessed.
Approximately 3 weeks after the first mailing, all firms in the sample were
contacted a second time, thanking those who had returned completed question-
naires and requesting responses from the remainder. Subsequent to the second
mailing, each eligible firm on the database was contacted by telephone. This contact
was particularly valuable in ascertaining reasons for reluctance in responding to the
questionnaire survey. Various reasons given included survey fatigue, particularly
with the amount of statutory questionnaire instruments; reluctance to supply
detailed financial information; fear that competitors would discover sensitive infor-
mation; scarcity of resources, particularly the pressure on the time of the firm
Table A.3 Response rate by contact mode

Contact Mode Date Absolute Response rate Rate
number of as a percentage (%)
responses of total
First: Covering letter and Mail Tuesday 3rd May 161 53.84 22.93
questionnaire 2005
Second: Covering letter and Mail Monday 30th 88 29.43 12.54
questionnaire May 2005
Third: Reminder and a short Telephone 30th May – 17th 50 16.7 7.1
conversation June
Fourth: Reminder with e-mail
active link to web page
Overall response rate 99.9 42.6
A.8 Age Profile of Respondents 127
owner; company policy; perception that they were not relevant to survey; unsure as
to how to answer; and habitual consignment of the survey instrument to the waste
paper basket. Four respondents completed the questionnaire survey over the tele-
phone. E-mail addresses were requested from non-respondents, who were then sent
a final reminder by e-mail with a direct link to the URL of the survey.
The methodology employed resulted in a response rate of 42.6%, or 299
respondents, as detailed in Table A.1. This is a relatively high response rate when
compared with those reported by Curran and Blackburn (2001), and is possibly
attributable to a number of reasons, including salience of the topic for respondents,
multiple contacts (especially personal contact by telephone), and mixed mode of
delivery. Finally, the data was entered into Statistical Package for Social Science
(SPSS) using a pre determined coding system. The survey data was analysed using
both SPSS and EViews statistical packages.
Analysis of survey data included not only testing multivariate models, but also
analysis of data on firm owners’ business goals, considerations when raising debt or
equity, and their financing preferences. This approach was adopted to provide a
more holistic explanation and complete understanding of demand side influences on
capital structure choice. Additionally, the method adopted seeks to overcome
Curran and Blackburn’s (2001) critique of employing solely quantitative techni-
ques. They take issue with Barkham et al. (1996), both epistemologically and
methodologically, for omitting owner-manager motivations, citing “. . . the key
importance of owner-managers in the decision making processes of the small
firm” (Curran and Blackburn 2001, p. 99). The research design adopted in the
present study directly addresses this criticism by specifically including the prefer-
ences and business goals of firm owners as central to the financing decision.
A.7 Profile of Respondents
Univariate data is presented in this section, contextualising the study and providing
a detailed profile of respondents. The population surveyed in this study is the
Business World “Next 1,500” list of companies, and so firms in the sample have
between 20 and 250 employees, thus fulfilling the employment criterion of the
European Commission (2003) definition of SMEs. Respondents comprise indepen-
dently held, non-financial business economy firms, excluding subsidiaries of multi-
national or national companies. An age and industry profile of 299 respondents to
the survey is provided in Table A.4.
A.8 Age Profile of Respondents
Because of the lower bound of 20 employees imposed in it’s composition, micro

firms and smaller firms with between 10 and 20 employees are excluded from the
population surveyed. Consequently, excluded firms may have a younger profile, as
Table A.4 Age and industry profile of respondents

Panel A. Panel B.
Firm age Proportion of Industry type (n ¼ 295) Proportion of
(n ¼ 297) respondents (%) respondents (%)
<5 years 5.1 Metal manufacturing and engineering 15.6
5–9 years 17.2 Other manufacturing 21.3
10–14 years 12.8 Computer software 17.3
development and services
15–19 years 10.4 Distribution, retail, hotels, and 27.5
catering
20–29 years 21.5 Other services 9.1
>30 years 33.0 Other 9.2
it typically takes time for firms to grow and mature (Evans 1987). This is reflected
in the age profile of respondents reported in Table A.4, as over 50% of respondents
are more than 20 years old. At the opposite end of the spectrum, 22% of firms are
less than 10 years old. The observed age profile is similar to that of previous studies
(Storey and Johnson 1987), and has a number of implications for the study. Firstly,
as there are a greater number of surviving older firms relative to younger firms, it is
anticipated that firms in the sample generally have a greater reliance on internal
equity due to the longer time period within which to accumulate retained profits,
ceteris paribus. Secondly, the potential under representation of smaller and younger
firms in the sample may result in financing issues experienced by these firms
possibly being understated. This is mitigated by the fact that results highlight
ways in which smaller and younger firms source finance, and overcome potential
financing constraints. The absence of non-surviving firms from the sampling frame
exacerbates the age bias, as a relatively greater proportion of younger firms fail
(Cressy 2006b). A potential age bias was investigated by recategorising age groups,
and composing three age groups of approximately equal size. Results of statistical
tests on recategorised age groups were compared with results on all age groups, and
found to be similar. This finding suggests that age bias is not a primary concern.
Significant sectoral differences are observed in the age profile of respondents, as
evidenced by data presented in Table A.9. Almost three-quarters of respondents
over 20 years old are in the “distribution, retail, hotels, and catering,” and both
manufacturing sectors. Respondents in the “computer software development and
services” sector comprise almost 50% of firms in the youngest age categories. This
outcome is consistent with the finding of Berggren et al. (2000), that manufacturing
firms are on average 15 years older than business service firms when evaluated at
the median. One of the reasons offered for this finding is the lower entry and exit
barriers within the business service sector in comparison with manufacturing
sectors. An implication for respondents in the “computer software development
and services” sector is that they may face exacerbated difficulty raising debt
finance, due not only to low levels of tangible assets, but also because of the lack
of a trading history suggested by their age profile. The Pearson chi-square measure
A.10 Size Profile of Respondents 129
reported in Table A.10 indicates that the relationship between age profile and
sector is statistically significant. Significance values for Goodman and Kruskal
tau, and uncertainty coefficients confirm this association, although low values for
both test statistics indicate that the relationship between the two variables is a fairly
weak one.
A.9 Sectoral Profile of Respondents
The population of firms surveyed was categorised across six sectors, derived
from two digit NACE codes, as detailed in Appendix C. Financial firms were
excluded from the sample, as their capital structures are atypical of the general
SME population because of regulatory factors. Analysis of the sectoral classifica-
tion detailed in Table A.4 reveals that almost three-quarters of respondents are
in sectors typified by high levels of collateralisable assets (sectors other than
“computer software development and services” and “other services”). Implications
of this sectoral profile relate to respondents’ capacity to raise debt finance, as
empirical evidence indicates that firms with high levels of lien free collateralisable
assets seeking external funding have a greater capacity to source external financing
from debt providers, ceteris paribus (Coco 2000; Heyman et al. 2008).
A.10 Size Profile of Respondents
Categorisation of size by gross sales turnover in Table A.5 reveals that over 30% of
respondents have gross sales turnover of between €5 million and €10 million, with
a further 30% reporting an amount between €10 million and €20 million. Whilst
rates of profitability and payment of dividends are the most significant factors in
financing the firm, turnover is an important and commonly-used measure of size
(Giudici and Paleari 2000; Lopez-Gracia and Aybar-Arias 2000; Cole 2008). A
crosstabulation of turnover with age of respondents presented in Table A.11 indi-
cates that the lowest turnover category (less than €1 million) is dominated by the
Table A.5 Size profile of respondents defined by employees and turnover

Panel A. Panel B.
Employees Proportion of Gross sales turnover (€) Proportion of
(n = 296) respondents (%) (n = 294) respondents (%)
20–50 42.4 < €1 million 3.1
50–99 30.5 €1 million to €2,999,999 11.6
100–250 27.0 €3 million to €4,999,999 13.3
€5 million to €9,999,999 31.6
€10 million to €20 million 32.0
>€20 million 8.5
youngest firms, whilst the largest turnover categories are comprised of firms with
the oldest age profile. This finding is consistent with the implication of Evans’
(1987) study that smaller firms are, on average, younger. An implication of respon-
dents’ profile is that younger, smaller firms may have a relatively greater reliance
on the personal funds of the firm owner, and a greater requirement for external
sources of finance. This may result in firm owners employing financial boots-
trapping methods to overcome a potential financing constraint (Winborg and
Landstrom 2001; Ekanem 2005; Ebben and Johnson 2006).
Sectoral differences in firm size are apparent from results presented in
Table A.13. Firms in the “distribution, retail, hotels, and catering” sector feature
most prominently in the largest turnover category, a profile that is consistent with
evidence cited in the Enterprise Observatory Survey (2007, p. 7). Firms in the
“computer software development and services” sector comprise the greatest pro-
portion of firms in the lowest gross sales turnover category, which may be partially
explained by their relatively younger age profile. The observed profile implies that
firms in this sector may have a greater external financing requirement due to lower
levels of retained profits, which is the most important source of investment finance
for SMEs (Vos et al. 2007; Cole 2008). The Pearson chi-square measure reported in
Table A.14 indicates that the relationship between turnover and sector is statisti-
cally significant. Significance values for Goodman and Kruskal tau, and uncertainty
coefficients confirm this association, although low values for both test statistics
indicate that the relationship between the two variables is a fairly weak one.
Size, as measured by employees, is also detailed in Table A.5. Firms in the
“distribution, retail, hotels and catering” and both manufacturing sectors employ
proportionately the greatest number of employees, whilst firms in the “computer
software development and services” sector are smaller. Once again, this may be
partly attributed to the age profile of respondents, which is inversely proportionate
to size. Additionally, it may reflect the labour intensive nature of the “distribution,
retail, hotels, and catering” sector.
A.11 Respondents’ Expenditure on Research and Development
A requirement for additional external financing is generally related to the presence

of positive NPV projects, or growth options. One indicator of the pursuit of growth
is current expenditure by firms on Research and Development (R&D). Successful
realisation of a firm’s R&D projects may be essential for revenue streams and future
growth options.
Research activity of respondents, expressed as a percentage of turnover spent on
R&D, is reported in Table A.6. Whilst this measure has a turnover bias, i.e. greater
absolute expenditure results in a relatively higher percentage in firms with smaller
turnover, this information is important in compiling a profile of respondent firms.
One-third of respondents do not engage in R&D, and a further 50% indicate that
A.12 Export Activity of Respondents 131
Table A.6 Reported R&D expenditure of respondents as a per-

centage of turnover
Percentage of turnover Proportion of
spent on R&D (n ¼ 287) respondents (%)
0 33.8
<10 51.6
10–29 9.8
30–50 3.8
>50 1.0
less than 10% of turnover is spent on R&D. 1% of respondents spend more than
50% of turnover on R&D, comprising firms in the lowest income category with the
youngest age profile. The relatively low expenditures on R&D reported by respon-
dents reflect national statistics of expenditure on R&D equalling 1.26% of Gross
National Product (GNP), which is lower than the average for the European Union of
27 countries (CSO 2006).
Analysis of data presented in Table A.15 reveals sectoral differences in R&D
expenditure. Firms in the “computer software development and services” sector
report the highest expenditure on R&D as a percentage of turnover. Whilst this
finding may reflect greater absolute expenditure on R&D by firms in the sector, it
may also be a function of lower turnover, as detailed in the preceding section.
Furthermore, this result possibly reflects a more intensive research focus by firms in
the “computer software development and services” sector than other sectors, such
as “distribution, retail, hotels, and catering”, for example. The relationship between
expenditure on R&D and sector is statistically significant, as indicated by signifi-
cance values for Pearson chi-square, Goodman and Kruskal tau, and uncertainty
coefficients presented in Table A.16. Low values for the latter two test statistics
indicate that this relationship is a weak one, however.
A relatively high expenditure on R&D relative to turnover has a number of
implications for the financing decision, particularly for firms with low levels of
collateralisable assets. Firstly, such firms may not prove attractive to debt financiers
due to low levels of fixed assets and a low level of cash flow with which to service
regular loan repayments. Secondly, R&D activities are generally firm-specific, and
residual value of research projects is typically low in the event of project failure
(Storey 1994b).
A.12 Export Activity of Respondents
A further important indicator of growth potential is the level of export activity, due
to the relatively limited size of the domestic market. Data presented in Table A.7
indicates a relatively low percentage of turnover generated from exports, with over
50% of respondents generating over 90% of turnover in the domestic market. These
results are consistent with evidence compiled by the Observatory of European
SMEs presented in Table A.8.
Table A.7 Respondents’ export revenue as a percentage of turnover
Exports as a percentage Proportion of
of turnover (%) respondents (%) (n ¼ 293)
0 27.3
<10 25.6
11–25 10.2
26–50 9.9
51–75 8.9
>75 18.1
Table A.8 Turnover generated from exports by Irish SMEs in 2005

Turnover generated Proportion of respondents
from exports (% of valid replies) (n ¼ 553)
<€150,000 61.7
€150,000–€500,000 16.7
€500,000–€1 million 5
€1 million–€2 million 8.4
€2 million–€5 million 3.4
>€5 million 4.9
Source: European Commission (2007, p. 15)
Export-led growth is important for all sectors, although firms in the “distribution,
retail, hotels, and catering” sector typically do not engage in a high degree of export
activity. Sectoral variations in percentage of turnover generated from exports are
evident from data presented in Table A.17. Firms reporting the highest levels of
export-generated revenue are in the “computer software development and services”
and both manufacturing sectors. This is not an unexpected result, and is consistent
with empirical evidence on SME export activity by sector reported in the Enterprise
Observatory Survey (2007, p. 15). The relationship between export revenue and
sector is statistically significant, as indicated by significance values for Pearson chi-
square, Goodman and Kruskal tau, and uncertainty coefficients presented in
Table A.18. Relatively low values for the latter two test statistics indicate that
this relationship is a weak one, however.
Financing implications for firms engaged in a high level of foreign trade emanate
primarily from fluctuations in exchange rates, which may have an adverse impact
on the financing of SMEs in a number of ways. Firstly, firms importing goods and
raw materials from non-euro currency countries are adversely affected by a weak-
ening euro. Firms exporting goods to non-euro currency countries are adversely
affected by a strengthening euro, resulting from decreased demand. Whilst expo-
sure to adverse changes in exchange rates has diminished in the euro zone with the
introduction of a common currency in 2003, it remains a significant factor for Irish
firms whose two main trading partners are the US and the UK. Adverse changes in
exchange rates are more problematic for SMEs than LSEs, because SMEs typically
do not have cash reserves to withstand adverse movements in exchange rates.
Furthermore, SMEs typically do not employ currency hedging instruments. Result-
ing levels of exposure to accounting and economic risk may affect the firm’s ability
to raise additional external financing.
Supporting Tables Presenting Results of Crosstabulations, Chi-square Tests, and

Directional Measures.
Table A.9 Crosstabulation of age by sector (% of respondents)

Age of Metal Other Computer Distribution, Other Other Total
firm manufacturing manufacturing software retail, hotels, services
(years) and engineering development and catering
and services
<5 0.3 1.7 1.7 0.7 0.7 0 5.1
5–9 1 1.4 8.8 3.4 0.7 2 17.3
10–14 0.7 3.1 2.7 3.1 1.7 1 12.3
15–19 1.7 2.4 1.7 2.4 1.4 1 10.6
20–29 6.1 5.1 2 4.4 2.4 1.7 21.7
>30 5.8 7.8 0.3 13.6 2.4 3.4 33.3
Total 100
Table A.10 Chi-square and directional measures for crosstabulation of age by sector
Value Approximate significance
Pearson Chi-square 88.34 0.000***
Goodman and Kruskal tau Firm age dependent 0.079 0.000***
Sector dependent 0.067 0.000***
Uncertainty coefficient Firm age dependent 0.094 0.000***
***
Statistically significant at the 99% level of confidence
Table A.11 Crosstabulation of age by turnover (% of respondents)

Age of Turnover
firm (years)
<€1 m €1 m to €3 m to €5 m to €10–€20 m >€20 m
€2,999,999 €4,999,999 €9,999,999
<5 1.4 0.7 0.7 1.4 1 0
5–9 1 3.4 3.1 4.4 4.4 0.7
10–14 0 2 1.4 3.4 5.1 1
15–19 0.3 2 1.4 3.1 3.4 0.3
20–29 0.3 1.4 2.4 8.8 6.8 2
>30 0 2 4.4 10.5 11.2 4.4
Total 100
Table A.12 Chi-square and directional measures for crosstabulation of age by turnover
Value Approximate
Significance
Pearson Chi-square 55.03 0.000***
Goodman and Kruskal Firm age dependent 0.031 0.009***
tau Turnover dependent 0.019 0.290
Uncertainty coefficient Firm age dependent 0.044 0.013***
Turnover dependent 0.047 0.013***
***
Table A.13 Crosstabulation of turnover by sector (% of respondents)

Turnover Metal Other Computer Distribution, Other Other Total
(in €m) manufacturing manufacturing software retail, hotels, services
and development and catering
engineering and services
<€0.750 0.3 0.3 2.1 0 0.3 0 3.1
€0.750– 1.7 1.7 4.8 2.1 0.7 0.7 11.6
€0.999
€1–€2.9 3.1 1.4 2.1 3.1 1.4 2.1 13
€3–€4.9 6.5 8.6 4.5 7.2 3.4 1.4 31.5
€5–€9.9 3.4 8.2 3.8 11 2.1 3.8 32.2
>€10 0.7 1 0 4.1 1.4 1.4 8.6
Total 99
Table A.14 Chi-square and directional measures for crosstabulation of turnover by sector
Value Approximate
significance
Pearson chi-square 62.91 0.000***
Goodman and Kruskal Turnover dependent 0.038 0.001***
tau Sector dependent 0.047 0.000***
Uncertainty coefficient Turnover dependent 0.068 0.000***
***
Table A.15 Crosstabulation of R&D expenditure by sector (% of respondents)

% of Metal Other Computer Distribution, Other Other Total
turnover manufacturing manufacturing software retail, hotels, services
spent on and development and catering
R&D engineering and services
0 5 4 3 13 5 4 34
<10 10 16 6 12 5 3 52
10–29 1 1 5 1 0 1 9
30–50 0 1 3 0 0 0 4
>50 0 0 1 0 0 0 1
Total 100
Table A.16 Chi-square and directional measures for crosstabulation of R&D expenditure by
sector
Value Approximate
significance
Goodman and Kruskal tau R&D expenditure dependent 0.094 0.000***
Uncertainty coefficient R&D expenditure dependent 0.135 0.000***
***
Table A.17 Crosstabulation of export revenue by sector (% of respondents)

Foreign Metal Other Computer Distribution, Other Other Total
sales as manufacturing manufacturing software retail, hotels, services (%)
% of and development and catering
turnover engineering and services
0 2 2 2 12 4 5 27
<10 5 5 2 8 4 2 26
11–25 2 3 2 2 1 0 10
26–50 2 3 2 3 0 0 10
51–75 1 3 4 1 0 0 9
>75 4 6 5 0.5 0.5 2 18
Total 100
Table A.18 Chi-square and directional measures for crosstabulation of export revenue by sector
Value Approximate
significance
Goodman and Kruskal tau Export revenue dependent 0.076 0.000***
Uncertainty coefficient Export revenue dependent 0.109 0.000***
***
Appendix B
Previous Related Literature
Most research on capital structure has focussed on public nonfinancial corporations with
access to U.S. or international capital markets. . . .Yet even 40 years after the Modigliani
and Miller research, our understanding of firms’ financing choices is limited
(Myers 2001, p. 82)
B.1 Introduction
This section outlines the literature that forms the theoretical bedrock for the
research. As noted in the opening chapter, a primary focus of earlier academic
and policy research on SME financing concerns the provision of adequate invest-
ment finance to firms in the sector. Corporate finance capital structure literature, by
contrast, is principally concerned with explanations for the debt/equity choice.
Hence, similar to previous studies investigating determinants of SME financing,
the theoretical basis for this study derives from capital structure theory developed in
the field of corporate finance.
Development of capital structure theories originate from the irrelevance proposi-
tions of Modigliani and Miller (1958) (often referred to as the “seminal” work of
Modigliani and Miller). Almost every treatment of capital structure in academic
papers and finance textbooks refers to the influential Modigliani and Miller (1958,
1963), and they spawned a vast literature of theoretical and empirical work. In brief,
the theory of capital structure has developed as follows: in 1958 Modigliani and
Miller proposed that a firm’s capital structure was independent of its cost of capital,
and therefore of firm value. The propositions of 1958 were based on a number of
unrealistic assumptions, and in 1963 taxes were introduced into the model. This led
to the development of trade-off theory (Miller 1977; DeAngelo and Masulis 1980),
whereby tax-related benefits of debt were offset by costs of financial distress.
Alternative approaches based on asymmetric information between “inside”
managers and “outside” investors include signalling theory (Ross 1977), and the
pecking order theory (Myers 1984; Myers and Majluf 1984). The latter postulates
137
138 Appendix B Previous Related Literature
that when internal sources of finance are not sufficient for investment needs the firm
has a preference to raise external finance in debt markets, with equity issues the least
preferable source. A further approach considered a nexus of relationships, charac-
terised as principal-agent relationships, and potential agency costs on the firm
(Jensen and Meckling 1976).
Research on the composition of capital structure in SMEs has a relatively shorter
history. The earliest papers investigating the financing of SMEs concentrated on
differences between SMEs and Publicly Listed Companies (PLCs) (Walker and
Petty 1978; Tamari 1980; Norton 1990; Ang 1991). Notwithstanding these dissimila-
rities, particularly differences in the nature of financial markets accessed by both types
of firm, capital structure theory developed in corporate finance formed the theoretical
basis for subsequent studies on the financing of SMEs (López-Gracia and Sogorb-Mira
2008, Heyman et al. 2008, Daskalakis and Psillaki 2008). Empirical evidence from
these studies confirms the relevance of capital structure theories for SME financing,
albeit employing a different rationale than their corporate finance counterparts.
This appendix proceeds as follows: beginning with the propositions of
Modigliani and Miller (1958), a number of capital structure theories from the
corporate finance literature are described. Each description includes a brief
consideration of empirical evidence, as well as how each theoretical approach
is applied in the SME literature. In the following section empirical evidence
from previous studies on the financing of SMEs is examined on two levels of
analysis, and conclusions are drawn. This review is succinctly summarised in
Table B.9 at the end of the appendix.
B.2 The Modigliani and Miller Propositions
Modigliani and Miller’s 1958 paper was groundbreaking, as it examined the effect
of capital structure on firm value within a micro-economic framework. By examin-
ing the effect of capital structure on the cost of capital, and therefore the market
value of the firm, Modigliani and Miller (1958) demonstrate that under a number
of assumptions the source of financing employed has no effect on firm value.
Modigliani and Miller conclude that firm value is determined by the profitability
and riskiness of its real assets, and not by its capital structure. This was contrary to
the prevailing view of the time, which contended that prudent use of cheaper debt
could increase the market value of the firm. The first proposition of Modigliani and
Miller (1958) is that there is no “magic” in financial leverage, and so the value of an
unlevered firm is equal to the value of a levered firm.
Modigliani and Miller’s second proposition (1958) is that the overall cost of
capital cannot be reduced by substitution of debt for equity, even though debt seems
cheaper. This is because, as more risky debt is added to the capital structure, equity
holders demand a risk premium, which would at some point counteract the benefit
from cheaper debt. They conclude that there is no advantage or disadvantage of
financing with debt, and as a result the value of the firm remains unchanged. Miller
(1991, p. 483), in his Nobel prize winning speech, put it thus:
B.3 Static Trade-Off Theory 139
The M&M [Modigliani and Miller] propositions are the finance equivalent of conservation
laws. What gets conserved in this case is the risk of the earnings streams generated by the
firm’s operating assets. Leveraging or deleveraging the firm’s capital structure serves
merely to partition the risk among the firm’s security holders.
Recognising that the assumption of perfect markets was unrealistic, in particular

the absence of corporate taxes, in 1963 Modigliani and Miller introduced taxes into
the model. Within the tax system interest payments on debt are allowable against
corporate tax, whereas dividend payments are not. Thus, the tax system provides
a “tax shield” to the firm, and so a firm with debt faces a lower corporate tax bill
than a similar all-equity financed firm, ceteris paribus. Modigliani and Miller
(1963) conclude that with corporate taxes the optimal capital structure occurs at
99.9% debt.
This proposition is highly unrealistic, and is rarely observed in reality (apart
from cases of extreme financial distress). The relatively low use of debt for
investment observed in practice suggests that other factors impinge on the equilib-
rium model proposed by Modigliani and Miller (Myers 2001), particularly in
relation to the restrictive assumptions on which the model is based. A number of
these factors may be categorised by static trade-off theory, theories based on
signalling and asymmetric information, and agency theory. Each theory is con-
sidered in succession in the following sections.
B.3 Static Trade-Off Theory
A key assumption of Modigliani and Miller’s propositions is that debt is risk free.
This assumption does not hold in reality, as debt must be serviced with regular
repayments of interest and principal. If a part debt-financed firm experiences a
decline in income from operations, it may default on some or all of its debt. Costs
associated with the possibility of default take many forms and can result in varying
degrees of financial distress. Likely costs of financial distress are difficult to
quantify, although Andrade and Kaplan (1998) estimated them to form 10% to
20% of a firm’s market value. There is therefore a trade-off between the tax benefits
of debt and potential costs of financial distress. A theoretical optimum is reached
when the present value of tax savings due to further borrowing is just offset by
increases in the present value of costs of distress, as shown in Fig. B.1. In
accordance with the trade-off theory, firms have an optimal debt ratio which they
attempt to maintain. There are, of course, limits to the use of interest tax shields, and
“. . .You can’t use interest tax shields unless there will be future profits to shield,
and no firm can be absolutely sure of that” (Brealey et al. 2006, p. 488). The trade-
off theory recognises that target debt ratios may vary from firm to firm. “Firms with
tangible assets and ample taxable income to shield ought to have high target ratios,
whilst unprofitable companies with risky, intangible assets ought to rely primarily
on equity financing” (Myers 2001, p. 91). There is, however, a pattern of financing
that trade-off theory cannot explain. According to the trade-off theory, the most
Market
value of
the firm
PV costs of financial
distress
PV debt-tax
shield
Value of an
unlevered firm
Optimal Capital Debt

Structure
Fig. B.1 The static-trade off theory of capital structure
profitable firms should potentially benefit most from employing an optimal level of
debt, ceteris paribus.
This is not observed in reality, however. Empirical evidence indicates that the
most profitable firms borrow least (Wald 1999; Myers 2001; Fama and French
2002), and Fama and French (1998) find that debt tax shields do not contribute to a
firm’s market value. By contrast, Graham (2000) finds that capitalised benefits of
the debt tax shield constitute almost 10% of firm value. Furthermore, Graham and
Harvey (2001) report that 44% of survey respondents have target debt ratios, and
Flannery and Rangan (2006) find evidence for partial adjustment to target debt
ratios. Notwithstanding limited empirical evidence for the trade-off theory, it
appears that whilst tax effects may have an effect on financing choice, they are
not of first-order importance (Myers et al. 1998; Graham 2003).
The relationship between leverage and the value of the debt tax shield is further
complicated by other shields which may prove more valuable. Depreciation and
investment credits reduce a firm’s taxable income and result in a decrease in the
likelihood of it being able to use its entire interest tax shield (DeAngelo and Masulis
1980). Furthermore, research and development expenditure can be expensed rather
than capitalised, reducing taxable income. Accordingly, firms with non-debt tax
shields should employ less debt in their capital structure, ceteris paribus. Empirical
evidence, however, reveals the opposite, finding that leverage is directly related to
the availability of non-debt tax shields (Titman and Wessels 1988). This can be
interpreted as evidence that assets that generated such tax shields can be used as
collateral for additional debt, suggesting support for the “. . . secured-debt hypothe-
sis” (Smart et al. 2007, p. 475), whereby firms with higher levels of tangible assets
can support higher levels of debt.
B.4 Application of Trade-Off Theory to the SME Sector 141
Japan
United States
France
Belgium
Germany
New Zealand
Country
United Kingdom
Sweden
Italy
Netherlands
Greece
Czech Republic
Poland
Republic of Ireland
0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00

Tax rate(%)
Fig. B.2 Combined corporate income tax rates (%) 2008

Source: OECD (2008)
Macroeconomic factors have a significant influence on the value of debt-tax

shields. Country-specific factors relating to rates of taxation and tax deductibility of
interest payments are of primary importance (Walsh and Ryan 1997). Although
virtually all countries permit firms to deduct interest payments from taxation
(McIntyre 2008), the debt tax shield reduces in value as the marginal tax rate
falls. Thus, profitable firms operating in high corporate tax jurisdictions have a
greater incentive to use the debt-tax shield than profitable firms in low tax jurisdic-
tions, ceteris paribus. For example, Desai et al. (2004) find that multinational
companies finance subsidiaries with debt rather than equity in jurisdictions with
higher corporate tax rates. The central government corporate income tax rate in the
Republic of Ireland is extremely low in global terms, as depicted in Fig. B.2. A
favourable corporate tax rate of 10% has applied to firms in the Irish manufacturing
and exporting services sectors since the 1980s, partly in order to attract foreign
direct investment. In 2003 a standard corporation rate of 12.5% was introduced for
all firms. Thus, the debt tax shield is not as advantageous to Irish-based firms.
(Although small business tax rates are lower than the corporate tax rate in a number
of countries, none are lower than the Irish corporate income tax rate).
B.4 Application of Trade-Off Theory to the SME Sector
Applicability of the trade-off theory to the SME sector has been the focus of a
number of studies (Heyman et al. 2008; López-Gracia and Sogorb-Mira 2008),
although the debt-tax shield may not be as relevant for SMEs as it is for publicly
quoted firms. This may be explained by consideration of two factors central to

trade-off theory; profitability, and financial distress. A number of studies indicate
that smaller firms are not as profitable as larger firms (McConnell and Pettit 1984;
Pettit and Singer 1985; Vos and Forlong 1996; Michaelas et al. 1999). Firms with
lower levels of profitability have less use for debt tax shields, ceteris paribus.
Additionally, Day et al. (1983) argue that the tax shield is less valuable to small
firms as they are generally less capital intensive. This is because smaller firms adapt
flexible production technologies in order to compete with larger companies
operating with lower average costs, maintaining an ability to respond swiftly to
changes in demand (Mills and Schumann 1985). This relatively lower capital
expenditure means that the debt-tax shield is of lesser value to smaller firms, ceteris
paribus.
A second component of the trade-off theory to consider is risk of financial
distress. The ultimate consequence of financial distress is bankruptcy, and it is
well established in the literature that “. . .young firms are more failure prone than
older ones” (Cressy 2006b, p. 103). Higher bankruptcy rates in younger firms are
indicative of the relatively higher business risk that smaller firms face, which may
be attributed to a number of factors. Firstly, smaller businesses may be overly
dependent on a small number of customers (Hudson et al. 2001). This is exacer-
bated by dependence of many SMEs on a single product or service (Cambridge
Small Business Research Centre, CSBRC 1992). These firms are particularly
vulnerable to financial distress, as loss of their principal customer(s) would severely
affect their chances of survival. Secondly, nascent and early-stage firms are partic-
ularly vulnerable to problems of undercapitalisation as shown in Fig. B.3. This may
be exacerbated by reduced access to sources of additional external finance due
to information opacity, and lack of a trading history. Thirdly, smaller firms
may be particularly vulnerable to economic shocks and adverse macroeconomic
Probability
of failure
Time trading
8 (Quarters)
Fig. B.3 Business closure rates by time trading

Source: (Cressy 2006b, p. 104)
B.4 Application of Trade-Off Theory to the SME Sector 143
conditions, which are typically exacerbated by the absence of hedging instruments

in their “financial portfolio.” Poorly diversified undercapitalised firms are particu-
larly vulnerable under adverse macroeconomic conditions.
The heightened business risk faced by younger, smaller firms may lead to
financial distress and bankruptcy costs. The impact of bankruptcy costs for the
SME owner has farther-reaching and more severe personal effects than in the case
of a publicly owned company. This is due to the well-documented integration of
SME owners’ personal finances with the financing of the firm (Ang 1992; Avery
et al. 1998). Adverse effects of bankruptcy may thus have implications for the
personal affairs of the owner, particularly in firms with unlimited liability. In this
case, “. . . consequences of business bankruptcy very often leads to personal bank-
ruptcy, and the impact of provisions for the transfer of management and ownership
to succeeding generations in a family enterprise” (McMahon et al. 1993, p. 77). An
additional onerous burden of bankruptcy for the SME owner is the considerable
negative effect on the owner’s reputation and self-esteem (Vos and Forlong 1996),
which may have adverse consequences for his personal life. Empirical evidence for
the effect of bankruptcy costs is inconclusive; Michaelas et al. (1999) state that
bankruptcy costs are not significant enough to prove a negative relationship
between risk and gearing, although Esperanca et al. (2003) find that bankruptcy
costs are a significant determinant of debt ratios. A caveat of these studies is use of
the coefficient of variation in profitability as a proxy for economic risk. This
measure does not encompass all aspects of risk for the SME owner, particularly
the proportion of personal wealth invested in the firm. Additionally, these studies do
not measure reluctance to undertake positive NPV projects due to the likelihood of
financial distress.
A further theory explains the level of debt employed in SMEs as a function of the
control aversion of the firm owner (Cressy 2006a). Cressy (2006a, p. 185) argues
that the psychological costs of borrowing outweigh the benefits, as the small firm
owner dislikes interference from debt providers. In Cressy’s model, as firms get
larger and less personal, aversion to bank interference diminishes, whereas in micro
firms control aversion restricts the amount borrowed. As shown in Fig. B.4, the
profit maximising optimum level of debt for the manager of a large firm (dashed
line) occurs at L* (Cressy 2006a). The indifference curve for the owner of a smaller
firm (full line), is upward sloping, as profits provide positive marginal utility and
borrowing provides negative marginal utility. Utility increases with higher profits
and lower borrowing, and thus the optimum level of borrowing of the control-
averse firm owner occurs at L** (Cressy 2006a, p. 185).
A combination of factors, namely, control aversion, heightened business risk,
and greater adverse consequences of financial distress suggest that the trade-off
theory may have limited applicability in SME financing. Whilst firms may consider
tax shield benefits when raising additional debt, the aforementioned factors appear
to have a greater influence on firm financing. Evidence from previous empirical
investigations of the applicability of trade-off theory to SMEs is considered in a
following section.
Profits
L
L** L*
Debt in the business
Fig. B.4 Effects of control aversion on the amount of borrowing

Source: (Cressy 2006a, p. 186)
B.5 Asymmetric Information and Signalling Theories
The Modigliani and Miller (1958) propositions were based on the assumption that
corporate “insiders,” and “outside” investors were privy to homogenous or sym-
metric information. An alternative approach to capital structure theory is based on
the assumption of asymmetry of information, i.e. that firm managers or “insiders”
possess private information about the firm that “outside” uninformed investors do
not. This implies that market prices of firms’ securities do not contain all available
information, and therefore managers or “insiders” may use financial policy deci-
sions to reveal information about firms’ revenue streams and risk. Four approaches
are discernible from the literature: interaction of investment and the financing
decision, proportion of debt as a signalling device, models based on risk aversion,
and market timing models.
Myers (1984) and Myers and Majluf (1984) present a signalling model that
combines investment opportunities available to the firm and its financing decisions.
Their pecking order theory is based on two primary assumptions: that a firm’s
managers know more about a firm’s revenue streams and investment opportunities
than outside investors, and that managers act in the interests of existing share-
holders. This information asymmetry implies that inside managers cannot convey
information to the markets about the true value of investment projects. Therefore,
announcement of an equity issue to new investors will be viewed as a “bad” signal,
as investors perceive that managers will only issue stock if they believe it to be
overvalued by the market. Underinvestment can be avoided if the firm sources
financing that is not subject to the information asymmetry problem. Funding
B.5 Asymmetric Information and Signalling Theories 145
investment projects with internal funds overcomes this adverse signalling problem.
When internal funds are exhausted, debt is preferred to external equity as it is less
susceptible to undervaluation due to information asymmetries. When internal cash
flow and safe debt are exhausted, the firm issues risky debt or convertibles before
common stock (Myers 1984).
The pecking order theory does not propose an optimum debt/equity ratio because
there are two types of equity, one at the bottom of the pecking order and one at the
top. Changes in the level of debt are not motivated by the need to reach a given debt
target, but are instead motivated by the need for external financing to fund positive
NPV projects once internal resources have been exhausted. A firm’s debt ratio
reflects its past history, through its cumulative requirement for external capital, its
ability to generate cash flow, its dividend policy, and finally, its investment oppor-
tunities. Thus, under the pecking order theory the ideal capital structure fluctuates
over time.
Empirical evidence for the pecking order theory in corporate finance is mixed. A
number of propositions of the theory are supported, such as that stock prices
decrease on announcement of equity issue (Korwar and Masulis 1986) and increase
on the announcement of debt issues (Kim and Stulz 1988); and a negative relation-
ship between debt ratios and past profitability (Rajan and Zingales 1995). Further
studies provide direct evidence for the pecking order theory (Shyam-Sunder and
Myers 1999; Graham and Harvey 2001), although Frank and Goyal (2003) find that
contrary to the pecking order theory net equity issues almost perfectly follow the
financial deficit.
Another approach based on information asymmetries is the signalling model
proposed by Ross (1977), whereby managers convey inside information to inves-
tors through the proportion of debt in the capital structure. Successful firms with
greater revenue streams can support greater leverage than those with lower revenue
streams, and the market believes that only the manager knows the true distribution
of the firm’s returns. The manager has an incentive to give the correct signal of the
firms’ quality to the market, as he benefits if the firms’ securities are more highly
valued by the market but is penalised if the firm goes bankrupt. In this way,
investors take higher debt levels as a signal of higher quality.
An alternative signalling approach proposed by Leland and Pyle (1977) is based
on managerial risk aversion. They propose that managers are naturally risk-averse
and will only hold or increase their share of firm equity if they believe that the
return from doing so outweighs the increased risk of their portfolio due to risky
equity. A manager’s willingness to invest is seen as a positive signal of future
projects, and is interpreted by the market as a signal of quality. Although the
manager incurs a welfare loss by investing more than is optimal in a project, this
is offset by a greater return for managers in high quality firms. Additionally, as
higher levels of leverage allow managers to retain a larger fraction of equity, use of
more debt can signal firm quality. As with Ross (1977), this approach proposes a
positive relationship between the level of leverage and firm value.
A further theory based on information asymmetries is the market timing model
proposed by Baker and Wurgler (2002). They propose that firms attempt to time the
market by issuing equity when their market values are high relative to book and past
market values, issuing debt when they are not. Therefore, the resultant capital
structure reflects the cumulative result of past attempts to time the market and is
strongly related to historical market share values. Alti (2006) reports support for the
market timing theory in the short run, but finds that its long run effects are limited.
Thus, in common with aforementioned approaches, whilst the theory is intuitively
appealing, it is not conclusively supported by empirical evidence.
B.6 Application of Asymmetric Information and Signalling

Theories to the Sme Sector
There are two contrasting views in the literature on the source of information
asymmetries in SME finance markets. One school of thought contends that external
suppliers of finance have superior information on the value of a firm’s investment
projects and prospects for survival, and therefore the SME bears the cost of
information asymmetries (Garmaise 2001). This view is supported by studies
detailing the entrepreneur’s excessive optimism about business prospects (Cooper
et al. 1988), and the high non-survival rate among new firms (Audretsch 1991;
Cressy 2006b). Additionally, survival rates among bank-financed firms are higher
than those among owner-financed firms (Reid 1991), indicating that financial
institutions are more skilled than insiders in appraising a firm’s chances of survival,
particularly in nascent and start-up firms. Berger and Udell (1990) state that banks
have adequate information to appraise a project and “sort-by-observed-risk” by
requiring more risky projects to provide collateral, whereas less risky projects are
not required to do so.
The contrasting view is that insiders have greater knowledge about a firm’s
investment projects, and may take advantage of this superior information to the
detriment of outsiders. Garmaise (2001) states that this view of information asym-
metries is more appropriate for established firms, which have a preference for the
pecking order of financing (Myers 1984; Myers and Majluf 1984). According to the
Berger and Udell (1990) paradigm, this view corresponds with the traditional
approach of banks, and thus they “sort-by-private-information” by requiring collat-
eral to protect against default in the event of project failure.
The latter view emphasises the lack of opacity in SME financing, which is
exacerbated by the relatively high cost of compiling information on individual
firms, the limited and fragmented market for this information, and difficulties in
signalling to the market. Application of the pecking order theory to SME financing
contends that increased information opacity in SMEs results in investments being
funded by inside equity, including the firm owner’s funds, as he has superior
information on the firm. Small firm owners thus try to meet their finance needs
from a pecking order of, first, their “own” money (personal savings and retained
earnings); second, short-term borrowings; third, longer term debt; and, least
B.6 Application of Asymmetric Information and Signalling Theories to the Sme Sector 147
preferred of all, from the introduction of new equity investors (Cosh and Hughes
1994). This means that small firms operate without targeting an optimal debt/equity
ratio as suggested by the trade-off theory, and reveals a strong preference for
financing options that minimise intrusion into their businesses. Following Myers
(1984) and Myers and Majluf (1984), levels of debt reflect the cumulative need for
external finance over time. Firms’ debt ratios differ, reflecting variations in factors
such as initial capitalisation, asset structure, profitability, and rates of retention.
Numerous studies report financing patterns consistent with the pecking order
theory, including Chittenden et al. (1996), Cressy and Olofsson (1997b), Michaelas
et al. (1999), Berggren et al. (2000), Coleman and Cohn (2000), Hall et al. (2000),
Lopez-Gracia and Aybar-Arias (2000), Romano et al. (2001), Watson and Wilson
(2002), Cassar and Holmes (2003), Ou and Haynes (2003), Cassar (2004), Hall
et al. (2004), Voulgaris et al. (2004), Baeyens and Manigart (2005), Gregory et al.
(2005), Johnsen and McMahon (2005), Sogorb Mira (2005), Ou and Haynes (2006),
Daskalakis and Psillaki (2008), Mac an Bhaird and Lucey (2010). These studies
emphasise that SMEs rely on internal equity and external borrowing to finance
operations and growth, and only a very small number of firms employ external
equity. A number of studies report that firms operate under a constrained pecking
order, and do not even consider raising external equity (Holmes and Kent 1991;
Howorth 2001). Other studies indicate that the financing preferences of SME
owners adhere to a modified pecking order, such as the High Technology Pecking
Order Hypothesis (HTPOH) (Oakey 1984; Brierley 2001; Hogan and Hutson 2005).
This theory propounds that firms with a particular profile (high-technology firms
with potential for high-growth rates) prefer to finance investment from internal
equity, followed by external equity, and finally debt financing, and is supported by
empirical evidence. In seeking to explain the apparent adherence of firms in the
SME sector to the pecking order theory, the primary question is whether it is
imposed by supply side factors, or if it is due to demand side choices.
One of the most frequently examined issues in SME financing addresses the
supply of finance to the sector, and enquires whether there is a financing gap.
Holmes and Kent (1991) describe the financing gap as having two components: a
knowledge gap, whereby the firm owner has limited awareness of the appropriate
sources of finance and the relative advantages and disadvantages of each source;
and secondly, a supply gap, whereby funds are either unavailable to small firms, or
the cost of debt to small firms exceeds the cost of debt to large firms. Authors in the
field of economics and SME finance have concentrated on the latter, with two
polarised views emerging. Stiglitz and Weiss (1981) present a model of credit
rationing in markets with imperfect information in which “good” projects are
denied funding because of credit rationing. This is viewed as an underinvestment
problem, where equity clears the market. The opposing theory of De Meza and
Webb (1987, 2000) proposes that the inability of lenders to discover risk character-
istics of borrowers results in socially excessive levels of lending. Thus, the pooling
of “good” projects with “poor” projects results in a lower interest rate charged to
“poor” projects and credit rationing of “good” projects. The central issue concerns
market efficiency. Many papers empirically investigate the subject of a financing
constraint in SMEs, both supporting (Fazzari et al. 1988, 2000) and refuting
(Levenson and Willard 2000) the phenomenon. Intervention to alleviate funding
gaps due to market inefficiencies, if they exist, or if intervention is the proper
response, is a question that has been comprehensively discussed by academics,
policy makers, and practitioners. Although evidence for a persistent equity gap is
inconclusive, Cressy (2002) opines that governments across the globe will continue
to intervene in SME capital markets because of political considerations.
An alternative approach to explaining the apparent adherence of SMEs to the
pecking order theory concerns preferences of the firm owner, or demand-side
issues. One reason for the observed hierarchy in financing patterns is the relatively
higher cost of external equity for smaller firms. The process of raising capital
through an Initial Public Offering of common stock (IPO) is more expensive per
share for SMEs due to the fixed costs of due diligence, distribution, and securities
registration (Berger and Udell 1998). Despite the reduced cost and lesser diligence
requirements of obtaining a listing on markets specifically oriented towards smaller
firms, such as the Irish Enterprise Exchange (IEX) or the Alternative Investment
Market (AIM), it remains a very costly process. Additionally, empirical evidence
suggests that the effect of underpricing is significantly more severe for smaller firms
(Buckland and Davis 1990; Ibbotson et al. 2001). Whilst the combination of these
costs is an impediment to stock market flotation, perhaps the greatest disincentive is
the resultant loss of control due to wider equity ownership.
The latter factor, along with the interrelated issue of managerial independence, is
commonly cited as the primary reason for adherence of SMEs to the pecking order
theory of financing (Bolton Committee 1971; Cosh and Hughes 1994; Chittenden
et al. 1996; Jordan et al. 1998). A number of studies report that desire for indepen-
dence is so great, SME owners eschew growth opportunities rather than relinquish
control (Cressy and Olofsson 1997b; Michaelas et al. 1998). This prevents firm
growth and increases in the number of employees (Berggren et al. 2000), and has
wider implications in restricting economic growth. Empirical evidence suggests
that desire to retain control and maintain managerial independence varies with
ownership structure and firm profile. Poutziouris (2002) finds that aversion to
external equity is more evident in family owned firms, partly because of succession
considerations. Further studies report that reluctance to employ external equity
from new investors is dependent on sector, finding that owners of firms in the
high-technology sector are willing to cede control in return for equity capital
(Oakey 1984; Hogan and Hutson 2005). Moreover, willingness to employ external
equity may be contingent on added capabilities of the equity provider. For example,
firm owners are willing to employ external equity from new investors in return
for managerial input and non financial competencies (Cressy and Olofsson 1997b;
Giudici and Paleari 2000; De Bettignies and Brander 2007).
A number of authors in the corporate finance literature propose that firms
overcome potential information asymmetry problems by signalling to the financial
markets through issuing debt or equity. Notwithstanding fundamental differences in
the nature of public debt and equity markets and the private debt and equity markets
typically accessed by SMEs, researchers assert that SMEs overcome information
B.7 Agency Theory 149
opacity by signalling to funders. Bester (1985) and Besanko and Thakor (1987)
state that provision of personal assets by the firm owner as collateral for business
loans may be interpreted as having a signalling function. Conversely, Coco (2000)
and Manove et al. (2001), state that collateral is used by financial institutions to
protect against credit exposure, rather than as a signalling mechanism. This view is
supported by Hanley and Crook (2005, p. 417), finding that “. . . the ‘menu
approach’ that underpins signalling models as lacking in realism.”
This evidence does not completely reject the role of signalling in SME financing,
however. A number of studies find that funders’ willingness to provide finance to
SMEs is positively related with the financial commitment of the firm owner to the
venture, particularly the amount of personal finance invested by a firm owner
(Storey 1994a; Blumberg and Letterie 2008). These studies report that the amount
of equity invested by the firm owner in a venture is a signal of the owner’s belief
that the venture will succeed, and reduces the likelihood of incurring increased risk
ex post. This view is consistent with the signalling approach based on managerial
risk aversion propounded by Leland and Pyle (1977).
B.7 Agency Theory
Integrating theories of finance, agency, and property rights, Jensen and Meckling
(1976) outline a nexus of relationships in publicly listed companies which could be
characterised as principal-agent relationships. Firms’ security holders (debtholders
and equityholders) are seen as principals, and firms’ management as agent, manag-
ing the principals’ assets. The principal-agent relation may be costly, because if
both are utility maximisers “. . .there is a possibility that the agent will not always
conduct business in a way that is consistent with the best interest of the principals”
(Jensen and Meckling 1976, p. 308). Jensen and Meckling identify three implicit
costs that may result from such relationships; monitoring costs incurred by the
principal, bonding costs incurred by the agent, and a “residual loss.” The principal
incurs monitoring costs to ensure the agent acts in the principal’s best interest,
limiting the agent’s unrepresentative activities. The agent incurs bonding costs by
guaranteeing that he will make choices to maximise the principal’s welfare. The
“residual loss” is borne by the principal, because despite monitoring and bonding
costs, it is not always possible to ensure the agent operates in a way which
maximises the welfare of the principal.
Conflicts between debtholders and equityholders arise because of the nature of
debt contracts, resulting in the unequal distribution of payoffs from an investment
project. If an investment yields high returns, debtholders receive a fixed interest
payment whilst equityholders capture most of the gains. However, if the investment
fails, debtholders bear the full amount of the losses because of limited liability.
Therefore, once debtholders have advanced capital to equityholders, the latter have
an incentive to take on riskier projects than intended by the debtholders. If the
riskier project succeeds, equityholders capture most of the gains, but if the project
fails they default and the debtholders incur the losses. This effect is known as the
“asset substitution effect,” and is a consequence of moral hazard in loan agree-
ments. Debtholders attempt to overcome this moral hazard and limit equityholders’
ability to expropriate wealth by incorporating protective covenants and monitoring
devices into debt agreements.
Another conflict of interest identified by Jensen and Meckling (1976) exists
between managers and equityholders in firms in which managers hold less than
100% of the residual claim of the firm. If a single individual owns a firm, the owner-
manager bears all the costs and realises all the benefits of his actions, and he will
make operational decisions to maximise his utility. As the manager’s ownership
stake in the firm decreases, he has an incentive to act for his own benefit, rather than
in the best interests of equityholders. Rather than endeavouring to maximise firm
value, the manager may consume extra perquisites or seek to expand the scale of the
firm beyond its optimal scale.
As both debt and external equity incur agency costs, there is an optimal debt-
equity ratio at which agency costs are minimised. Potential agency costs related to
equity financing are at a maximum when the owner-manager has no equity holding.
Conversely, these costs fall to zero when the owner-manager owns 100% of the
equity of the firm. Potential agency costs related to debt financing are positively
related to the proportion of debt employed in the capital structure of the firm; as
leverage levels fall, potential agency costs decrease. Therefore, the agency cost
curve of the firm is a concave or U-shaped function of the ratio of debt to external
equity. The optimal ratio of debt to external equity is that point at which agency
costs are minimised.
Empirical evidence supports theoretical agency models predicting positive rela-
tionships between leverage and firm value (Harris and Raviv 1990), and leverage
and a lack of growth opportunities (Stulz 1990). By contrast, recent papers based on
survey evidence do not support agency theory (Graham and Harvey 2001; Brav
et al. 2005). In conclusion, although economic problems of agency costs are
apparent in financing tactics (Myers 2001), empirical evidence from the corporate
finance literature does not support a general explanation of financing based on
agency theory.
B.8 Application of Agency Theory to the SME Sector
The effect of agency costs is likely to be more significant if businesses are small
(Hand et al. 1982), as agency problems are more pronounced when information
asymmetries are greater, and when the agent has an incentive to engage in high risk
activities at the expense of funders (Barnea et al. 1981). Unique characteristics of
SMEs increase the potential for agency costs, and introduce new types of agency
problems. These features include: “alternative organisational forms, absence of
publicly traded shares, risk taking tendency of entrepreneurs, limited personal wealth
of firm owners and shortened expected duration for the firm” (Ang 1991, p. 4),
B.8 Application of Agency Theory to the SME Sector 151
“conflicts in perception regarding the intentions of the entrepreneur, the heightened

probability of failure, and credibility of commitments and signals made by owners
with limited wealth holdings” (Keasey and Watson 1993, p. 41). Additionally, agency
costs are not constant across all firms. Potential agency costs increase with intangi-
bility of assets, as growth options increase and asset specificity rises (Gompers 1995).
Furthermore, incentives and opportunities for the owner-manager to gamble with
outside investors’ claims are greatly enhanced when the firm becomes financially
distressed (Keasey and Watson 1993).
Application of agency theory to the SME sector has spawned a vast literature,
focussing on the relationship between firm owners and suppliers of external capital.
Potential conflicts that may arise between firm owners and providers of debt are
different from those that may arise between firm owners and providers of equity, as
are the techniques employed to counteract potential agency problems. Suppliers of
private equity seek to minimise possible agency problems by employing a number
of techniques at frequent stages in the investment process. At the outset, venture
capitalists conduct an extensive due diligence process before investing in a com-
pany (Manigart et al. 1997). When investing capital, suppliers of private equity
employ a number of control mechanisms throughout the investment process. Three
methods common to venture capital providers include; use of convertible securities,
syndication of investment, and staging capital investment (Gompers 1995).
Sahlman (1990) states that the staging of capital investment is the most effective
control mechanism a venture capitalist can employ. Shorter duration between
funding rounds increases the effectiveness in monitoring the firm. Intensity of
monitoring is negatively related to expected agency costs, and the venture capitalist
always retains the ultimate answer to agency problems – “. . . abandonment of the
project” (Gompers 1995, p. 1462).
Whilst private equity is an important source of capital for a limited number of
SMEs, debt is by far the most commonly used source of external capital (Binks and
Ennew 1998; Cole 2008). Vos and Forlong (1996) report that, as agency costs of
debt are negatively related with size, potential costs are greater in the SME sector
than in the corporate sector. This is partly attributable to the well documented fact
that reliable information on SMEs is rare and costly to obtain for financial inter-
mediaries (Baas and Schrooten 2006). Potential problems arising from agency
relationships with debt providers consist of moral hazard and adverse selection.
Adverse selection arises at loan origination when providers of debt have difficulty
in discriminating between “good” and “bad” investment projects, resulting in
financing constraints for small businesses. A number of studies emphasise potential
problems of adverse selection for the SME sector (Stiglitz and Weiss 1981; Berger
and Udell 1998; Hyytinen and Vaananen 2006). A demand-side consequence of
adverse selection for SMEs is that borrowers may be reluctant to apply for loans in
the belief that their application will be rejected. Kon and Storey (2003) show that
the scale of discouragement depends on, among other things, screening error of
banks and the scale of application costs.
Moral hazard refers to the possibility of the SME owner changing his behaviour
to the detriment of the debt provider after credit has been granted. The firm owner
has an incentive to alter his behaviour ex post by favouring projects with higher
returns and greater risk. Debt providers seek to minimise agency costs arising from
these relationships by employing a number of lending techniques. Baas and
Schrooten (2006) propose a classification of four lending techniques: asset-based
lending, financial statement lending, small business credit scoring lending (transac-
tions-based or “hard” techniques); and relationship lending (a “soft” technique). An
alternative classification by Berry et al. (2004) identifies two approaches to lending:
the “gone concern” approach, and the “going concern” approach, which are com-
parable to Baas and Schrooten’s (2006) “hard” and “soft” techniques respectively.
These techniques are considered in the following sections, particularly those most
frequently employed; asset-based and relationship lending.
Asset-based lending: Lending to SMEs by financial institutions is frequently
“collateral-based” (Kon and Storey 2003, p. 45), and firms report that lack of
security offered is the primary reason cited for refusal of a term loan (Cruickshank
2000; Basu and Parker 2001; Ayadi 2008). Empirical evidence from a number of
countries indicates the pervasiveness in use of asset-based techniques to advance
debt. For example, Black et al. (1996) find that ratio of loan size to collateral
exceeds unity for 85% of small business loans in the UK, and Berger and Udell
(1990) report that over 70% of all loans to SMEs are collateralised.
Provision of collateral fulfils a number of roles; it provides an asset for the bank
in the event of project failure (Bartholdy and Mateus 2008); it provides an incentive
for commitment to the entrepreneur and attenuates moral hazard (Boot et al. 1991);
it provides a signal to the bank that the entrepreneur believes the project will
succeed (Storey 1994a); it mitigates information asymmetries, and thus may alle-
viate imperfections in credit markets, which may reduce credit rationing (Besanko
and Thakor 1987); it may also help in the renegotiation of loans under financial
distress (Gorton and Kahn 2000). The requirement of banks for collateral to secure
debt is motivated solely by the need to be compensated for ex post changes in their
exposure to risk (Keasey and Watson 1993). The collateralised lender has a claim
on specific assets of the principal in the event of the borrower becoming bankrupt
(Rajan and Winton 1995). Therefore, the expected profit function for the bank is:
YB
E ¼ p½K ð1 þ iÞ ð1 pÞ½C K ð1 þ r Þ
K ¼ loan amount
C ¼ collateral
P ¼ probability of success
where the bank still obtains collateral of value C, less the income which could have
been obtained from the investment (Storey 1994b, p. 209).
A unique feature of SME debt markets is the personal commitment of the firm
owner in securing business loans. Empirical evidence indicates that personal
guarantees and provision of personal assets as collateral are important for firms
seeking to secure business loans (Ang et al. 1995; Avery et al. 1998). These
B.8 Application of Agency Theory to the SME Sector 153
commitments are akin to quasi-equity, but as they are not recorded in the business
financial statement the owner’s contribution to the firm is underestimated (Ang
1992). Pledging “outside” collateral may be even more effective in countering
problems of moral hazard, as the firm owner may place a greater value on the
asset than the market valuation. Additionally,
Willingness to put your own money into a venture is a pretty effective test of its worth
and a high personal stake is a powerful incentive to good stewardship
(Black et al. 1996, p. 73).
Liquidation of personal assets causes a net welfare loss (Coco 2000), and results in
disutility to the firm owner. The borrower’s risk preference incentives are limited as
the likelihood increases that he will feel the loss personally (Mann 1997b), even if
personal commitments represent “. . .only a small fraction of the value of the loan”
(Berger and Udell 2006, p. 639).
An important aspect of the collateral-based lending technique is enforceability
of the lender’s collateral claims in the event of default, as the power of collateral
ultimately depends on whether the priority rights of lenders are upheld in bank-
ruptcy (Berger and Udell 2006). This is especially important in terms of alleviating
problems related to adverse selection. Beck et al. (2004) report that better protec-
tion of property rights has a relatively greater effect on, and increases external
financing to smaller firms. Problems in enforcing collateral rights are more preva-
lent in countries with underdeveloped financial infrastructures, compelling SMEs to
rely on leasing, supplier credit, and development banks (Beck and Demirguc-Kunt
2006).
A major disadvantage of asset-based lending techniques are monitoring and
legal costs (Chan and Kanatas 1985). Additionally, assets provided as collateral
must be of sufficient quality and quantity to support the loan (Berger and Udell
1995). An associated issue for lending institutions concerns the issue of valuation
of collateral, which may change over time. Probably the greatest disadvantage of
asset-based lending techniques is that they do not fully overcome problems of moral
hazard and adverse selection, because not all firm owners have equal access to
collateral (Storey 1994b). This is especially true for high-technology start-ups and
capital-intensive projects where the loans required are typically large (Storey
1994b; Ullah and Taylor 2005). Because of these drawbacks, Baas and Schrooten
(2006) contend that the asset-based lending technique is generally used as a
substitute for relationship lending if the term of the relationship is short.
Relationship lending: Relationship lending is based on “soft” information gen-
erated by a bank’s experience with a lender (Baas and Schrooten 2006) through
“continuous contact with the firm and the firm owner in the provision of financial
services” (Berger and Udell 1998, p. 645). As a firm becomes established and
develops a trading and credit history, reputation effects alleviate the problem of
moral hazard (Diamond 1989), facilitating borrowing capacity. Studies emphasise
the importance of relationship lending in funding SMEs (Berger and Udell 1995;
Cole 1998), and Hanley and Crook (2005) state that a pre-existing reputation is the
single most important determinant in inducing a bank to extend a loan. A substan-

tial volume of empirical evidence suggests additional benefits of relationship
lending, including lower interest rates ( Berger and Udell 1995; Keasey and Watson
2000), lower collateral requirements (Harhoff and Korting 1998; Elsas and Krahnen
1998), access to increased amounts of finance, and protection against credit
crunches (Berger and Udell 1998). The importance of lending relationships for
provision of finance to the sector is emphasised by studies highlighting the destruc-
tive effects on relationship lending of the consolidation of the banking sector
through mergers (Cole 1998; Berger and Udell 2002), making it too costly for
banks to provide relationship-based services (Berger and Udell 1998); and by
resultant changing practices within banks, such as making lending decisions cen-
trally (Berger and Udell 2006).
Further techniques to reduce agency: Additional lending techniques employed
by financial institutions to advance debt finance to informationally opaque small
firms include financial statement lending and credit scoring. Financial statement
techniques entail basing the lending decision on financial statements of the firm.
The decision to provide debt finance is thus dependent on the strength of the balance
sheet and income statements of applicants (Baas and Schrooten 2006). Credit
scoring lending techniques augment data provided in financial statements with
additional information, such as the creditworthiness and financial history of the
firm owner, to predict probability of repayment (Frame et al. 2001). The effective-
ness of this technique is based on the quality of available data (Baas and Schrooten
2006). These latter approaches require more analytical skills and monitoring than
asset-based lending approaches (Berger and Udell 1998), and are more costly to
administer. Berry et al. (2004, p. 118) conclude that the approach adopted by
lending institutions “. . .varies from case to case,” and ultimately depends on the
availability and cost of acquiring information.
Recent developments in recommendations on banking laws and regulations
issued by the Basel Committee on Banking Supervision, otherwise known as the
Basel II Accord, may have implications for lending to the SME sector (Ayadi
2008). The agreement proposes adoption of more risk-sensitive minimum capital
requirements for banks. Financial institutions may therefore attach more attention
to the relative riskiness of borrowers, and will require more information than
heretofore. This will place greater reporting and disclosure requirements on
SMEs, although “safer” firms may benefit from lower interest rates and greater
access to loans. Smaller, riskier SMEs may face greater difficulty in sourcing debt
finance, higher interest rates, and greater collateral requirements (Tanaka 2003).
The foregoing discussion indicates that agency issues have a significant influ-
ence on access to, and use of, finance for SMEs. Techniques employed by principals
to overcome potential agency costs, particularly problems of moral hazard, deter-
mine the source and amount of finance employed. Evidently, particular firm and
owner characteristics are important in fulfilling the requirements of funders and
securing finance. Empirical evidence from previous studies on the influence of firm
and owner characteristics in overcoming agency related problems are considered in
the following section.
B.9 Empirical Evidence of Determinants of SME Capital Structure 155
B.9 Empirical Evidence of Determinants of SME Capital

Structure
As evidenced from the foregoing analysis of capital structure literature, empirical

research on SME financing has lagged that of the corporate sector. A proliferation
of studies in recent years has remedied this deficit somewhat. The majority of
research investigating SME financing consists of empirical tests of theoretically
derived hypotheses. These studies are now considered in assessing accumulated
empirical evidence on SME financing.
Early academic studies investigating the financing of SMEs comprise predomi-
nantly descriptive work, reporting differences between financial structures of small
firms and larger corporations (Norton 1990; Ang 1991). As the literature developed,
authors investigated theoretical explanations for SME capital structures. These
works commonly tested theoretically derived models on panel data, typically
employing regression techniques (Hall et al. 2004; Voulgaris et al. 2004; López-
Gracia and Sogorb-Mira 2008; Heyman et al. 2008; Daskalakis and Psillaki 2008).
A summary of a number of previous studies is presented in Table B.9 at the end of
this appendix, detailing the author, country, sample size, method of analysis,
theoretical perspective, and principal findings. Consistencies in results from a
number of papers support similar theoretical explanations for SME capital struc-
ture, although a significant number of issues remain unresolved.
The synopsis of previous research detailed in Table B.9 indicates that previous
studies can generally be categorised as “firm characteristic” or “owner characteris-
tic” studies, depending on the level of analysis. A number of studies employ a
multi-level approach, combining firm and owner characteristics. These approaches
differ substantially with respect to the means of data collection, methods of analysis
employed, and presentation of findings. The majority of “firm characteristic”
studies adopt the positivist approach applied in corporate finance, developing and
testing multivariate regression models utilising panel data. This data is generally
sourced from secondary sources; for example, Hall et al. (2004) utilise panel data
from the Dun and Bradstreet database. These studies seek to explain dependent
variables, commonly debt ratios, in terms of firm characteristics such as firm size,
age, asset structure, profitability, growth opportunities, and legal organisation.
Additionally, differences in capital structures across industry sectors are commonly
investigated (Mac an Bhaird and Lucey 2010).
What may be termed “owner characteristic” studies seek to explain firm
financing in terms of firm owners’ objectives and preferences, such as; desire to
retain control and independence, propensity for risk taking, personal values, busi-
ness goals and objectives, and other personal characteristics. Data employed in
these studies is commonly obtained from interviews or questionnaire surveys
specifically designed for this purpose (Jordan et al. 1998). These studies typically
comprise smaller samples with fewer observations, and data is generally analysed
employing descriptive techniques (Michaelas et al. 1998; Poutziouris 2003).
In seeking to discover more complete explanations for SME capital structures, a

number of researchers combine both levels of analysis. These studies typically
collect data on owner and firm characteristics employing questionnaire surveys. A
variety of statistical techniques are employed to analyse data, including structural
equation modelling (Romano et al. 2001) and multivariate regression methods
(Jordan et al. 1998). Empirical evidence from each of these approaches is consid-
ered in the following sections.
B.10 “Firm Characteristic” Studies
Similar to the approach adopted in corporate finance, “firm characteristic” studies

investigate the extent to which debt ratios are determined by firm characteristics,
including firm size, age, asset structure, profitability, growth opportunities, and
industry sector. These studies commonly employ short-term, long-term, and total
debt ratios as dependent variables (López-Gracia and Sogorb-Mira 2008). Despite
being the most important source of investment finance for SMEs, studies employing
internal equity as the dependent variable are rare (Ou and Haynes 2006). “Firm
characteristic” studies are commonly representative of a broad range of sectors, and
sample sizes are typically large. For example, Sogorb Mira (2005) and Hall et al.
(2004) employ samples comprising 6,482 and 4,000 firms respectively. Notwith-
standing significant inter- and intra-industry differences, a number of consistent
results have emerged, some of which are discussed in the following paragraphs.
Discussion is arranged around a number of firm characteristics which commonly
feature as independent variables in models tested, and which are pertinent for the
present study.
Firm size: Researchers advance the argument that larger firms should find it
easier to raise debt finance than smaller firms, due to lower bankruptcy costs, lower
agency costs, and relatively lower costs of resolving information asymmetries
(Cassar 2004). Firm size can be defined in a number of ways, and previous studies
employ various variables to proxy for size, including number of employees
(Berggren et al. 2000), natural logarithm of asset size (Cassar and Holmes 2003),
and sales turnover (Ou and Haynes 2003), depending on the information available.
Empirical evidence presented in Table B.1 indicates a positive relationship between
long-term debt and size for all studies, regardless of the proxy used for firm size.
These findings are consistent with the view that smaller firms are offered, and
employ less debt due to scale effects (Cassar and Holmes 2003). A further reason
for observed positive relationships may be collateral effects, as the natural loga-
rithm of total assets is commonly employed as a proxy variable for size. Firms with
a greater amount of collateralisable assets have capacity for higher long-term debt
ratios ceteris paribus, and tend to match maturity of debt with that of assets
(Bartholdy and Mateus 2008).
The negative relationship between use of short-term debt and size reported in
most studies is consistent with the view that smaller firms are heavily reliant on
B.10 “Firm Characteristic” Studies 157
Table B.1 Results from previous studies concerning the relationship between debt financing
and firm size
Short-term Long-term Total Sample size (Country)
debt debt debt
Chittenden et al. (1996) þ n.s.s. 3,480 (UK)
Michaelas et al. (1999) þ þ 3,500 (UK)
Coleman and Cohn (2000) þ 4,637 (USA)
Hall et al. (2000) þ 3,500 (UK)
Esperanca et al. (2003) þ 995 (Portugal)
Cassar and Holmes (2003) n.s.s. þ þ 1,555 (Australia)
Voulgaris et al. (2004) þ þ þ 132 (Greece)
Hall et al. (2004) þ 4,000 (eight countries)
Sogorb Mira (2005) n.s.s. þ þ 6,482 (Spain)
Ghosh (2007) þ 1,141 (India)
Heyman et al. (2008) 1,132 (Belgium)
Daskalakis and Psillaki (2008) þ 3,258 (France and
Greece)
López-Gracia and Sogorb-Mira þ 3,569 (Spain)
(2008)
Bartholdy and Mateus (2008) n.s.s. þ 1,416 (Portugal)
Mac an Bhaird and Lucey n.s.s. þ 299 (Ireland)
(2010)
n.s.s. ¼ not statistically significant at the 95% level of confidence
short-term debt (Garcia-Teruel and Martinez-Solano 2007). This relationship may

result from firms being unwilling or unable to employ long-term debt because of
relatively higher transaction costs, thus having a greater reliance on short-term debt.
The relationship between total debt and firm size is positive for most studies,
notwithstanding potential confounding opposite effects of short-term and long-
term debt (Hall et al. 2000). These findings indicate that larger firms have relatively
lower costs in overcoming information asymmetries (Cassar and Holmes 2003),
and thus have a greater capacity to employ higher debt ratios. Furthermore, larger
firms, as defined by asset size, have a relatively greater capacity for debt financing,
ceteris paribus.
Firm age: Firm age is the fundamental variable in financial growth life cycle
models, and is central to capital structure theories. Firm age may be employed as a
proxy variable in consideration of agency theory. Theoretical propositions suggest
that firms gain access to increased amounts of external financing as they mature and
develop a reputation, which lessens potential problems of moral hazard (Diamond
1989). Lenders are thus more likely to advance credit facilities based on previous
transactions (Cole 1998). Additionally, firm age may be employed as an indepen-
dent variable in testing propositions of pecking order theory. Theoretically, firms
become less reliant on sources of external funding over time as debt is retired and
firms become increasingly dependent on retained profits (Myers and Majluf 1984;
Myers 1984). Empirical evidence from previous studies indicates that debt (both
short-term and long-term) is negatively related with age (Table B.2).
These findings indicate a pattern of financing consistent with the pecking order
theory, i.e. increased use of retained profits for investment projects as debt is retired
and firm age
Short- Long- Total Sample size (Country)
term debt term debt debt
Chittenden et al. (1996) n.s.s. 3,480 (UK)
Michaelas et al. (1999) 3,500 (UK)
Coleman and Cohn (2000) 4,637 (USA)
Hall et al. (2000) 3,500 (UK)
Esperanca et al. (2003) n.s.s. n.s.s. 995 (Portugal)
Hall et al. (2004) n.s.s 4,000 (eight countries)
Johnsen and McMahon (2005) þ 9,731 (Australia)
López-Gracia and Sogorb-Mira (2008) 3,569 (Spain)
Bartholdy and Mateus (2008) n.s.s. 1,416 (Portugal)
Mac an Bhaird and Lucey (2010) n.s.s. 299 (Ireland)
over time. Additionally, a number of studies emphasise that the relationship

between source of finance and age is more complex, in particular that patterns of
financing over time are not necessarily linear. Researchers investigate non-linearity
by including squared or cubed independent variables to test quadratic and cubic
functions (Fluck et al. 1998). These models constitute a more sophisticated investi-
gation of firm financing, surmounting the assumption of linearity in financial
growth life cycle models.
Profitability: Trade-off and pecking order theories predict contrasting relation-
ships between profitability and use of debt. Trade-off theory espouses a positive
relationship between profitability and use of debt, in order to reduce tax liability.
The pecking order theory propounds that debt is the preferred source of finance for
positive NPV projects when sources of internal equity are exhausted, suggesting a
negative relationship between profitability and debt. The direction of the coefficient
for an independent profitability variable should therefore indicate which theory has
greater relevance to SME financing.
Coefficients for the relationship between debt and profitability in previous
studies are typically negative, as evidenced by results presented in Table B.3.
These relationships indicate that firms employ debt finance when retained profits
are insufficient for investment requirements, suggesting that debt is a direct substi-
tute for retained profits. Results imply that firms are financed in a manner consistent
with the pecking order theory (Myers 1984; Myers and Majluf 1984), with retained
profits the preferred source of financing for positive NPV projects. This finding
emphasises the importance of profitability in financing the sector, as retained profits
are the single most important source of finance for SMEs (Ou and Haynes 2006;
Cole 2008).
Asset structure: Firms’ asset structures may have a significant influence on the
means of external finance employed, primarily because financial institutions
employ asset-based lending techniques when advancing debt to overcome potential
agency problems of moral hazard. Long-term debt and mortgages are typically
secured on fixed assets, whilst short-term debt is commonly advanced subject to
and profitability
debt debt debt
Chittenden et al. (1996) n.s.s. 3,480 (UK)
Michaelas et al. (1999) 3,500 (UK)
Hall et al. (2000) n.s.s. 3,500 (UK)
Esperanca et al. (2003) 995 (Portugal)
Voulgaris et al. (2004) 132 (Greece)
Hall et al. (2004) n.s.s. 4,000 (eight countries)
Sogorb Mira (2005) 6,482 (Spain)
Heyman et al. (2008) 1,132 (Belgium)
Daskalakis and Psillaki (2008) 3,258 (France and
Greece)
López-Gracia and Sogorb-Mira 3,569 (Spain)
(2008)
Bartholdy and Mateus (2008) n.s.s. 1,416 (Portugal)
and tangible assets
debt debt debt
Chittenden et al. (1996) þ 3,480 (UK)
Michaelas et al. (1999) þ þ þ 3,500 (UK)
Hall et al. (2000) þ 3,500 (UK)
Cassar and Holmes (2003) þ 1,555 (Australia)
Esperanca et al. (2003) þ 995 (Portugal)
Hall et al. (2004) þ 4,000 (eight countries)
Sogorb Mira (2005) þ þ 6,482 (Spain)
Voulgaris et al. (2004) þ þ 132 (Greece)
Johnsen and McMahon (2005) þ 9,731 (Australia)
Heyman et al. (2008) þ 1,132 (Belgium)
Daskalakis and Psillaki (2008) 3,258 (France and
Greece)
Bartholdy and Mateus (2008) þ 1,416 (Portugal)
Mac an Bhaird and Lucey þ þ þ 299 (Ireland)
(2010)
provision of collateral in the form of current assets, such as debtors or inventory

(Coco 2000; Ayadi 2008). Collateral provides funders with security in the event of
default, with maturity of the asset typically matching maturity of the debt
(Bartholdy and Mateus 2008).
Empirical evidence from all previous studies presented in Table B.4 indicates a
positive relationship between use of long-term debt and asset structure, (with the
ratio of fixed assets to total assets commonly employed as a proxy variable for asset
structure). These findings support the proposition of Bartholdy and Mateus (2008),
that asset structure is the single most important determinant of SME capital
structures. Results for the majority of studies presented in Table B.4 reveal a
negative relationship between short-term debt and fixed assets. These findings
suggest that firms’ short-term debt is not secured on fixed assets, either because
of insufficient fixed assets, or because it is secured on other (short-term) collateral,
or unsecured. The implication in the former case is that firms employ inappropriate
sources of finance (short-term rather than long-term debt) due to insufficient lien-
free collateralisable fixed assets.
Evidence from previous studies is not unanimous, however. Positive relation-
ships between short-term debt and fixed assets reported by Voulgaris et al. (2004)
and Mac an Bhaird and Lucey (2010) indicate that financial institutions’ collateral
requirements are met by fixed assets when advancing short-term debt. This evi-
dence suggests that firms have adequate collateral to secure debt finance, but have a
preference for short-term debt.
Results provide empirical evidence of the use of asset-based lending techniques
by financial institutions to overcome information asymmetries and potential agency
costs, with both short- and long-term debt requiring security. These findings suggest
that firms with high levels of collateralisable assets have a greater capacity for debt
financing, whilst firms lacking these assets may be debt constrained.
These results suggest inter-industry differences in capital structures, as firms in
industries typified by greater levels of collateralisable assets have the capacity for,
and may employ, greater levels of debt than firms with a higher concentration of
intangible assets (Brierley and Kearns 2001). Indeed, intra-industry capital struc-
tures may be more comparable than inter-industry capital structures (Harris and
Raviv 1991). Previous empirical investigations of inter-industry differences in
capital structures typically included industry dummy variables in regression mod-
els. Empirical evidence of sectoral effects is mixed, with studies both supporting
(Michaelas et al. 1999; Hall et al. 2000) and failing to support this hypothesis.
Examples of the latter include Balakrishnan and Fox (1993) who conclude that firm
specific characteristics are more important than structural characteristics of indus-
try, and Jordan et al. (1998) who find that financial and strategy variables have
greater explanatory power than industry specific effects.
Growth: Previous studies propose that growth, particularly high growth, is
positively related to the proportion of external financing employed (Gompers and
Lerner 2003). Proxy variables commonly employed for growth include the percent-
age increase in recent sales turnover, or percentage increase in level of total assets.
High-growth firms typically have a large external financing requirement (Storey
1994b). Firms with sufficient lien-free collateralisable assets may have access to
debt financing, although potential agency costs may result in a financing restraint
for some firms. This is especially true for firms investing in firm specific, or
intangible assets (Myers 1977). Hall et al. (2000) state that this agency problem
can be alleviated by the use of short-term instead of long-term debt, thus hypothe-
sising a positive relationship between growth and short-term debt.
Results from previous studies presented in Table B.5 provide support for this
hypothesis. One exception is the finding of Sogorb Mira (2005), who explains that
the type of assets linked to growth opportunities may be long-term in nature, and
Table B.5 Results from previous studies concerning the relationship between financing and
growth
Short- Long- Total debt Sample size (Country)
term debt term debt
Chittenden et al. (1996) n.s.s. n.s.s. n.s.s. 3,480 (UK)
Hall et al. (2000) þ n.s.s. 3,500 (UK)
Cassar and Holmes (2003) þ n.s.s. þ 1,555 (Australia)
Esperanca et al. (2003) þ n.s.s. þ 995 (Portugal)
Voulgaris et al. (2004) þ þ 132 (Greece)
Hall et al. (2004) þ n.s.s. 4,000 (eight countries)
Johnsen and McMahon (2005) þ þ þ 9,731 (Australia)
Sogorb Mira (2005) þ þ 6,482 (Spain)
Daskalakis and Psillaki (2008) þ (France) 3,258 (France
and Greece)
Table B.6 Results from previous studies concerning the relationship between financing and tax-
rate
Short-term Long-term Total Sample size
debt debt debt (country)
Jordan et al. (1998) 173 (UK)
Michaelas et al. (1999) n.s.s. n.s.s. n.s.s. 3,500 (UK)
Sogorb Mira (2005) n.s.s 6,482 (Spain)
López-Gracia and Sogorb-Mira n.s.s 3,569 (Spain)
(2008)
Bartholdy and Mateus (2008) þ n.s.s. 1,416 (Portugal)
thus the maturity of debt matches that of the assets. Significant findings from two
other studies support this explanation. The positive relationship between total debt
employed and growth supports the hypothesis that high-growth firms and firms
investing in growth opportunities require additional external finance due to insuffi-
cient internal resources. Consistent with the pecking order theory, firms employ
debt to finance this growth, particularly short-term debt.
Tax rate: Trade-off theory proposes that profitable firms should employ opti-
mum levels of debt financing to take advantage of debt-tax shields (DeAngelo and
Masulis 1980). A number of studies have empirically tested the relevance of this
theory to SME financing by regressing debt ratios on the effective tax rate. Results
presented in Table B.6 indicate that empirical evidence on the relevance of trade-
off theory for SME financing is inconclusive. Jordan et al. (1998) and Sogorb Mira
(2005) report a relationship contrary to predictions of trade-off theory. Both studies
explain this negative relationship by the effect of the amount of tax paid on retained
earnings, and consequently on the level of debt employed. Although Michaelas
et al. (1999) find that tax rates do not significantly influence the level of debt in
SMEs, they conclude that tax considerations may be important in the long term
capital structure decision.
Non debt tax shields: Lack of empirical evidence indicating the relevance of tax
advantages of debt may be partly explained by the significant negative relationships
between debt and non-debt tax shields discovered in a number of studies (Michaelas
et al. 1999; Sogorb Mira 2005; López-Gracia and Sogorb-Mira 2008). Use of non-
debt tax shields lessens the importance of the debt-tax shield, and consequently the
level of debt employed. By using non-debt tax shields such as investment credits or
accelerated depreciation costs, firms seek to avoid distress costs or other adjustment
costs which “. . . may be more important in particular instances” (López-Gracia and
Sogorb-Mira 2008, p. 119). These results imply that firms with higher levels of
tangible assets can maintain higher levels of debt, supporting the secured-debt view
propounded by Smart et al. (2007) and Bartholdy and Mateus (2008).
Although combined results presented in Tables B.6 and B.7 suggest that non-
debt tax shields are more important than debt-tax shields for SMEs, Michaelas et al.
(1999), p. 120) conclude that “. . . It is hard to say that a firm’s tax status has
predictable material effects on its debt policy.”
Operating risk: Given the importance of retained profits as a source of invest-
ment finance in SMEs (Cole 2008), it is hardly surprising that the coefficient of
variation in profitability over the period studied is commonly used as a proxy for
operating risk. Titman and Wessels (1988) propose that volatility of a firm’s
earnings is negatively related with its level of debt because of potential agency
and bankruptcy costs. Results from previous studies presented in Table B.8 indicate
that the opposite effect is true in SMEs, i.e. that the level of debt employed is
positively related to operating risk as measured by volatility in earnings. These
findings indicate that bankruptcy costs are not sufficiently large to deter risky SMEs
from employing additional debt, particularly short-term debt. Furthermore, these
results may indicate “distress” borrowing, particularly in adverse macroeconomic
and non debt tax shields
Short-term Long-term Total Sample size
debt debt debt (country)
Chittenden et al. (1996) 3,480 (U.K.)
Michaelas et al. (1999) n.s.s. n.s.s. 3,500 (U.K.)
Sogorb Mira (2005) 6,482 (Spain)
López-Gracia and Sogorb-Mira 3,569 (Spain)
(2008)
and operating risk
Short-term debt Long-term debt Total debt Sample size (country)
Jordan et al. (1998) þ 173 (UK)
Esperanca et al. (2003) þ n.s.s. þ 995 (Portugal)
B.11 “Owner Characteristic” Studies 163
conditions (Jordan et al. 1998). A notable discovery in these studies is the difficulty
in calculating an appropriate variable for bankruptcy costs.
In summary, a substantial body of evidence from empirical investigations of firm
characteristic determinants of SME capital structures indicates a number of consis-
tent results; for example, the positive relationship between debt finance and growth;
the positive relationship between long-term debt and tangible assets; and the
negative relationship between debt finance and profitability. There are also a
number of conflicting results, however, such as relationships between short-term
debt and firm size, and tangible assets. Notable features of previous studies are the
lack of statistical significance, and the low explanatory power of a number of
models, especially in models employing short-term debt as a dependent variable.
These shortcomings prompt researchers to seek alternative explanations for SME
financing, commonly employing a variety of methodologies.
B.11 “Owner Characteristic” Studies
The influence of firm owners’ business goals, objectives, and preferences on SME
financing is understated, as witnessed by the relative paucity of published papers
employing this approach. Variables examined in previous studies investigating the
influence of “owner characteristics” on a firm’s capital structure may be delineated
by two approaches; (1) a firm owner’s personal characteristics, such as age, gender,
race, education, and previous business experience, and (2) a firm owner’s prefer-
ences, business goals, and motivations. Data for studies adopting these approaches
are typically sourced from interviews and postal questionnaires, and are commonly
analysed employing descriptive and non parametric techniques. Sample sizes are
generally smaller than those in quantitative studies employing panel data, resulting
in limitations to the generalisability of results.
A number of studies have examined the potential influence of personal char-
acteristics of the firm owner on sources of financing employed. Personal character-
istics investigated include, race (Scherr et al. 1993; Hussain and Matlay 2007;
Salazar 2007), gender (Brush 1992; Carter and Rosa 1998; Boden and Nucci 2000;
Coleman and Cohn 2000), tertiary education (Cassar 2004), age (Romano et al.
2001), and years of business experience (Coleman and Cohn 2000; Cassar 2004),
amongst others. Whilst researchers generally do not find significant empirical
evidence supporting the proposition that firm owners’ personal characteristics
determine the source of financing employed (Cassar 2004), some significant results
have emerged. For example, Chaganti et al. (1995) find that women are more likely
to employ internal than external equity; Romano et al. (2001) discover that older
business owners are less likely to employ external equity; Scherr et al. (1993) find
that owners’ age is negatively related with debt, and also that more debt is obtained
if the owner is married and less if he is black. Coleman and Cohn (2000) test if firm
owners’ age, education, years of experience, prior experience in a family-owned
business, and gender influence the capital structure decision, and find education of
the firm owner to be the sole significant variable. In summary, although findings
from previous studies suggest that personal characteristics of the firm owner may
influence financing choice in SMEs, the bulk of empirical evidence indicates that
these variables are not of primary importance (Carter and Rosa 1998).
Perhaps the single most important “owner characteristic” variable directly
related to SME financing is personal wealth of the firm owner. Results from
previous studies indicate that personal wealth of the entrepreneur influences the
rate of business start-ups (Evans and Jovanovic 1989; Fairlie 1999). The level of
wealth of the firm owner, and his willingness to invest personal equity and provide
personal assets as collateral for business loans, is most important in the start-up and
nascent stages (Berger and Udell 1998; Fluck et al. 1998; Ullah and Taylor 2007).
Access to external financing is typically most difficult in early stage firms because
of information opacity. Wealth constraints may contribute to the commonly expe-
rienced problem of undercapitalisation. The influence of wealth of the firm owner
on capital structure is dependent on: (a) his propensity for risk, (b) his wealth
relative to the capital requirements of the firm, and (c) availability of external
sources of finance. The latter source may be dependent on the amount of personal
equity the firm owner is willing to invest in the venture (Bruns and Fletcher 2008).
Despite the importance of personal wealth of the firm owner to SME financing,
empirical studies on the relative influence of this variable on the capital structure of
SMEs are rare due to the sensitive nature of the data.
A further approach adopted in investigating capital structure in SMEs from the
level of analysis of the firm owner is to examine the influence of firm owners’
preferences, motivations, and business goals on firm financing. These studies seek
to explain SME capital structures with reference to non-financial factors, including,
desire for control, managerial independence, motivation for being in business,
business goals, and propensity for risk (LeCornu et al. 1996; Michaelas et al.
1998; Jordan et al. 1998; Romano et al. 2001). Previous studies state that these
factors may be more important than firm-characteristic factors in explaining SME
financing (Barton and Matthews 1989; Norton 1990; Jordan et al. 1998), although
one caveat of these studies is that they generally assume that firm owners have
access to multiple sources of financing.
Firm owners’ desire to retain control of the firm and maintain managerial
independence is a defining characteristic of the SME sector (Bolton Committee
1971). This well-documented objective is frequently cited as the primary reason
SME capital structures adhere to the pecking order theory of financing (Myers
1984; Myers and Majluf 1984), in particular the reluctance of SMEs to employ
additional external equity (Berggren et al. 2000) or debt (Cressy 2006a). Retention
of control of the firm is commonly dependent on firm owners’ growth aspirations.
Firms pursuing a growth strategy frequently require large amounts of additional
external financing to augment internal resources (Gompers 1999). Empirical
evidence indicates that firms with owners committed to retaining control are
financed by internal equity (Holmes and Zimmer 1994), which may be augmented
by short term bank debt (Storey 1994b). Lack of adequate finance from these
sources may lead owners to eschew growth opportunities (Davidsson 1989), thus
B.12 Conclusion 165
maintaining control of the firm. Willingness to employ additional external equity is

thus related to the motivation for growth and readiness to share equity (Berggren
et al. 2000), although this is dependent on the attractiveness of the investment
opportunity for outside investors (Storey 1994b).
Empirical evidence suggests that desire for control is not common across all
SMEs, and varies according to ownership structure. Previous studies have shown
that desire for control is greater in family firms, primarily for reasons of intergen-
erational transfer (Poutziouris 2002; Lopez-Gracia and Sanchez-Andujar 2007).
The aspiration of retaining control may not be constant over the life cycle of the
firm, however, and may change for reasons such as change of lifestyle or lack of a
successor, for example. Fitzsimmons and Douglas (2006, p. 79) state that “. . .there
may come a point where the stress and responsibility of decision making, coupled
with the entrepreneur’s realisation that he/she lacks critical market, industry or
management information, causes the entrepreneur to switch from autonomy prefer-
ence to autonomy aversion.” In summary, empirical evidence from previous studies
indicates that the strategic objective of maintaining control of the firm has a
significant influence on the means of financing employed, although this goal is
not constant across ownership structures.
A related issue examined in previous investigations of “owner characteristic”
explanations for SME capital structures is the financial objective function of firm
owners. Neo-classical finance theory propounds that the primary objective of the
firm manager is maximisation of the value of the firm (Smart et al. 2007). In
publicly quoted firms this is achieved by maximising the market price of common
stock. Ownership of SMEs, by contrast, is typically closely held, and common stock
is not publicly traded (Ang 1991). The goal of value maximisation in SMEs
therefore manifests itself in a different way to that of publicly quoted companies.
Cooley and Edwards (1983) suggest that the objective of “maximising the value of
the selling price of the firm” is a suitable proxy for value maximisation in SMEs.
This objective is not, however, consistent with maintaining control of the firm, and
is more in keeping with the objective of equity holders aiming to harvest their
investment. Empirical evidence from previous studies indicates that the primary
financial objective of SME firm owners is not maximisation of the selling price of
the firm (LeCornu et al. 1996). The primary objective of firm owners is maximisa-
tion of net income or net profit, and the secondary objective is to maximise growth
of net income (Cooley and Edwards 1983; LeCornu et al. 1996). These financial
objectives are consistent with maintaining control of the firm. Firm owners thus
choose sources of finance commensurate with this objective, rather than sourcing
finance for expansion or growth, which may lead to relinquishing control.
B.12 Conclusion
The theoretical foundation for empirical investigations of determinants of SME

capital structures has been adopted from corporate finance, utilising theories based
on agency, debt-tax shields, signalling, and information asymmetries. Results from
empirical studies in the SME literature confirm the relevance of these theoretical
approaches to the sector, notwithstanding fundamental differences in ownership
structure, financial objectives, and the nature of the financial markets accessed.
Adopting the statistical methodology commonly employed in corporate finance
studies, empirical studies in the SME literature test regression models on panel data
consisting of detailed accounting information. Results from these studies reveal that
firm characteristic variables such as firm age, size, asset structure, profitability, risk,
and growth are significant determinants of capital structure. A common finding of
previous empirical investigations is the considerable effect of information opacity
on the financing of SMEs, highlighting the applicability of agency and information
asymmetry theoretic approaches. Inconclusive evidence on the relationship
between the marginal tax rate and leverage suggests that the trade-off theory has
limited applicability to SME financing.
Investigating composition of capital structure at the level of analysis of the firm
owner, results from previous studies detail the importance of firm owners’ prefer-
ences, motivations, and business goals on the means of financing employed. These
results substantiate the managerial or strategic perspective espoused by Barton and
Matthews (1989) and Balakrishnan and Fox (1993), although few authors have
empirically tested the managerial “strategic objective” approach (Jordan et al. 1998).
The foregoing consideration of previous capital structure empirical research
highlights a number of gaps in the literature. Previous studies examining demand-
side determinants of capital structure in SMEs have been dominated by the quanti-
tative approach of the financial economics perspective. Whilst a number of SME
financing characteristics may be explained by theoretical propositions of agency
and pecking order theories, such as positive relationships between growth and use
of debt finance, and between tangible assets and use of long term debt, for example;
many unresolved issues remain. These unanswered questions may be profitably
examined by considering a combination of both firm and owner levels of analysis.
Table B.9 Previous studies investigating SME financing
Author Country (Sample Method Theoretical perspective Principal findings
size)
Studies adopting the “firm characteristic” approach
B.12 Conclusion
Oakey (1984) South-East Analysis of survey Finance and innovation 74% of firms rely on internally generated profits
England and questions with chi- Externally oriented firms are generally more
Scottish squared tests innovative and progressive. In Scotland, newer
Development high-tech small firms contribute to a higher
Region (114) incidence of external capital funding
Peterson and 12 countries Bivariate analysis of Asymmetric Information. Life cycle of capital structure among small growing
Schulman (1987) (200) primary data (4,000 Agency theory firms depends on age, size, and economic
interviews) development of host country. Most firms initially
dependent on personal funds and “f ” connections,
and over time are more able to rely on bank debt
Holmes and Kent Australia Bivariate analysis on Pecking order theory Support for a constrained version of the pecking order
(1991) (391) primary (questionnaire) theory. Where additional funds are sought, owners
data prefer “additional funds provided by owners” and
debt
Davidson and Dutia US (86,000) General linear model Small firms are less liquid than large firms and have
(1991) Anova lower profit margins which may contribute to an
undercapitalisation problem. Small firms use more
short-term debt than large firms
Van der Wijst and Former Least squares dummy Debt-tax shield. Agency Most of the determinants of financial structure
Thurik (1993) Western variable regression theory presented by the theory of finance appear to be
Germany analysis of pooled cross- relevant for the small business sector investigated.
(27) section and time series Non-debt tax shields (approximated by
data depreciation) are the exception
Balakrishnan and US (295) Random effects model Debt-tax shield Firm specific effects contribute most to variance in
Fox (1993) Agency theory leverage. Inter-industry differences are not nearly
167
Signalling as important
(continued)
Table B.9 (continued)
168

size)
Berger and Udell US (3,400) Ordinary least squares Relationship lending Borrowers with longer banking relationships pay lower
(1995) regression on cross- interest rates and are less likely to provide
sectional panel data collateral
Van Auken and US (190) Canonical correlation Financial growth life cycle Long-term assets are employed as collateral to secure
Holman (1995) analysis approach long-term debt. Accounts payable and current debt
are used to finance receivables and inventories
Chittenden et al. UK (3,480) Ordinary least squares Life cycle model Asset structure, profitability, size, age, and stock
(1996) regression on cross- Pecking order theory market flotation are significant determinants of
sectional panel data Agency theory capital structure. Financial structure reflects trade-
offs of owner-managers. Collateral is important in
securing debt. Short-term debt is negatively related
to profitability
Vos and Forlong New Zealand Spearman’s rank analysis Agency theory Debt has a negative agency advantage in SMEs
(1996) (35) (decreases total utility of the firm owner due to loss
of control, accountability, and increase in personal
risk). Debt is only used when additional funds are
necessary
Berger and Udell US (1993 Bivariate analysis of Pecking order theory The financial growth life cycle paradigm is depicted by
(1998) NSSBF data)a sources of finance by Agency theory categorising capital structures of SMEs by four
size and age Financial growth life sources of equity and nine sources of debt. Capital
cycle model structure varies with firm size and age.
Vulnerability of SME financing to the
macroeconomic environment is highlighted
Fluck et al. (1998) US (541) Two-limit Tobit estimates Reputation theory At the beginning of firms’ life cycles, the proportion of
Monopoly lender theory funds from internal sources increases with age,
whist the proportion from banks, venture
capitalists, and private investors declines. These
Appendix B Previous Related Literature
patterns eventually reverse themselves

Michaelas et al. UK (3,500) Ordinary least squares Trade-off theory Firm size, age, profitability, growth, and future growth
(1999) regression on cross- Life cycle model opportunities, operating risk, asset structure, stock
sectional panel data Pecking order theory turnover, and net debtors have an effect on the level
Agency theory of short-term and long-term debt. Tax effects do
not influence the total debt position of small firms.
B.12 Conclusion
Capital structure is time and industry dependent.

Short-term debt increases during recession
Ang et al. (2000) US (1,708) Ratio analysis Agency theory Agency costs are; (1) higher when an outsider rather
Analysis of means using than an insider manages the firm; (2) inversely
t and chi-squared tests related to the manager’s ownership share; (3)
increase with the number of non-manager
shareholders, and; (4) are lower with greater
monitoring by the banks
Lopez-Gracia and Spain (Valencia) Multivariate Manova model Pecking order theory Larger companies show higher reliance on self-
Aybar-Arias (461) finance. Business sector affects the type of finance
(2000) adopted
Hall et al. (2000) UK (3,500) Ordinary least squares Trade-off theory Long-term debt is positively related to asset structure
regression on cross- Pecking order theory and size; and negatively related to age. Short-term
sectional panel data debt is negatively related to profitability, asset
F test structure, size, and age; and positively related to
growth. Intra industry variation is evident
Scherr and Hulburt US (1987 and Ordinary least squares Debt maturity Default risk, maturity of assets, and capital structure
(2001) 1993 NSSBF regression on cross- are important determinants of debt maturity.
data)a sectional panel data Limited evidence for the influence of growth
options, level of asymmetric information, tax
status, and sector
Fu et al. (2002) Taiwan (1,276) Ordinary least squares Profitability is positively related to capital growth, and
regression on cross- equity financing; and negative related to debt
sectional panel data financing
169
(continued)
170
size)
Forsaith and Australia (871) Univariate analysis on Pecking order theory Most SMEs are closely held. Only a small proportion
McMahon secondary (longitudinal Life cycle approach undertake new equity financing. Smaller firms have
(2002) survey) data a more limited equity base. When new equity
financing is undertaken, the amount is significant
relative to the existing equity base. Greater growth
is evident among SMEs that are more willing to
employ new equity financing
Zoppa and Australia (871) Logit analysis on secondary Pecking order theory Support for a modified pecking order theory that
McMahon (longitudinal survey) reflects the special circumstances and nuances
(2002) data of SME financing
Watson and Wilson UK (626) Regression analysis on Trade-off theory Support for the pecking order theory. It is particularly
(2002) primary survey data Pecking order theory strong in relation to closely held firms. There may
Agency theory be a pecking order within debt types
Esperanca et al. Portugal (995) Ordinary least squares Modigliani and Miller Bankruptcy costs are significant. The ability to provide
(2003) regression propositions collateral is the determining factor for undertaking
Industry effects Trade-off theory debt. Creditors weigh collateral value more than
examined using Agency theory earnings. Younger firms are most dependent on
Bonferroni and debt. There is a positive relationship between debt
Tamahane tests and growth. Industry and size effects are important
Cassar and Holmes Australia (1,555) Ordinary least squares Trade-off theory Asset structure, profitability, and growth are important
(2003) regression on cross- Pecking order theory determinants of capital structure.
sectional panel data Support for trade-off and pecking order models
Reid (2003) Scotland (150) Dynamic financial model Agency theory. If debt is relatively cheap, it will be used
using the Pontryagin Signalling theory comprehensively, and the trajectories of debt,
Maximum Principle capital, and output over time will rise until a
stationarity level is reached. Only then will a
dividend be paid. If equity is relatively cheap, debt
will still be acquired in the early stage after
financial inception, and output and capital will also

grow rapidly
Voulgaris et al. Greece (143 Non-linear least squares Pecking order theory For SMEs and LSEs, debt increases with size; debt is
(2004) SME 75 LSE) using Marquardt’s negatively related to profitability as predicted by
algorithm the pecking order theory. Growth results in higher
use of short-term debt. Higher profits are found to
induce higher use of short-term debt for SMEs
B.12 Conclusion
Hall et al. (2004) Belgium, Ordinary least squares Trade-off theory In some countries SMEs rely a great deal on internal
Germany, regression on cross- Pecking order theory funds; for all countries long-term debt is positively
Spain, sectional panel data related to asset structure. In Belgium, Spain, UK,
Ireland, Italy, F test and Italy, availability of collateral is very important
Netherlands, in raising long-term debt. Firms rely on their own
Portugal, and resources, and are only able to borrow if they have
UK collateral
(4,000)
Ullah and Taylor UK (133) Descriptive analysis of “Technology-based small Science-park firms are more likely to have been
(2005) primary (survey) data firm finance” and refused finance than off-park firms. Financial
location constraints vary with stage of development, and
diminish as firms survive and mature. Some firms
eschew external finance in order to retain control.
Off-park firms believe their location has a positive
impact on access to finance
Johnsen and Australia Ordinary least squares Trade-off theory Sector is an important influence on financing
McMahon (9,731) regression on cross- Life cycle model behaviour in its own right (not just as a proxy
(2005) sectional panel data Pecking order theory variable for size, age, profitability, growth, asset
Agency theory structure and risk)
Sogorb Mira (2005) Spain (6,482) Regression analysis on Trade-off theory Non-debt tax shields and profitability are negatively
cross-sectional panel Pecking order theory related with debt. Size, asset structure, and growth
data Agency theory options are positively related with debt. Maturity
matching is evident. The pecking order theory is
supported
(continued)
171
172

size)
Gregory et al. (2005) US (1993 Multinomial logistic Agency theory. Financial Partial support for the financial growth life cycle
NSSBF data)a regression growth life cycle model model
Pecking order theory
Ou and Haynes US (1993 and Multivariate logistic Agency theory Importance of external equity for SMEs in general
(2006) 1998 NSSBF regression Pecking order theory is possibly overstated. Internal equity is the most
data)a important source of financing for SMEs. The
pecking order theory is supported
Ebben and Johnson US (146) Principal components Resource dependence Small business owners rely less on personal financing
(2006) analysis Organisational learning and joint-utilisation of resources as other sources of
financing become available. Firms generally
increase use of customer-related techniques over
time
Ortqvist et al. (2006) Sweden (592) Structural equation Trade-off theory Asset structure is a determinant of debt financing. Firm
modelling Pecking order theory size, age, growth, and profitability are not
significant determinants of debt ratios for new
ventures
Hussain and Matlay UK (36) Descriptive analysis of SME finance literature Family and close network associates are important for
(2007) primary (interview) data financing, especially for ethnic minorities. Personal
sources of finance decline in importance after start-
up, and are replaced by bank finance in white
owned firms
Ullah and Taylor UK (133) Descriptive analysis of “Technology-based small 80% of respondents are finance constrained, split
(2007) primary (survey) data firm finance” evenly between supply-side and demand-side
financial constraints. A majority report funding
difficulties at start-up, which recede as firms
expand. Firm owners’ personal finance is the
primary source at start-up. A small majority
employ venture capital

Colombo and Grilli Italy (386) Ordinary least squares and “Technology-based small Italian NTBFs resort to external finance, especially
(2007) Tobit regression firm finance” bank loans, only when personal resources are
exhausted. Results suggest NTBFs suffer from
credit rationing, both in access to, and amount of,
bank loans secured
B.12 Conclusion
Heyman et al. (2008) Belgium (1,132) Ordinary least squares and Trade-off theory. High growth firms and firms with less tangible assets
two stage least squares Agency theory. have lower debt ratios. More profitable firms have
regression Pecking order theory less debt. Evidence for maturity matching
Ortiz-Molina and US (995) Ordinary least squares Information asymmetry Loan maturity is shorter for more informationally
Penas (2008) regression on cross- opaque firms, and for older, less experienced firm
sectional panel data owners. Loan maturity increases with collateral
pledges. Personal collateral is associated with
longer maturities than business collateral
Blumberg and Netherlands Bivariate models Signalling theory Personal wealth, particularly home ownership, is
Letterie (2008) (1,140) important in accessing external finance. Owners
using their own capital are more likely to receive
credit. Banks value commitment more than signals
López-Gracia and Spain (3,569) Generalised moments Trade-off theory Evidence for pecking order and trade-off theories. The
Sogorb-Mira method and two stage Pecking order theory importance of non-debt tax shields, growth
(2008) least squares regression opportunities, and internal resources are
highlighted
Bartholdy and Portugal (1,416) Instrumental variables Trade-off theory The asset side of the balance sheet determines the
Mateus (2008) employed in estimating Pecking order theory liability side. This relationship is determined by
a Seemingly Unrelated asymmetric information and collateral. Trade-off
Regression (SUR) and pecking order theories are rejected
(continued)
173
174

size)
Mac an Bhaird and Ireland (299) Ordinary least squares Agency theory. The influence of age, size, ownership structure and
Lucey (2010) regression Industry Pecking order theory provision of collateral is similar across industry
effects examined using sectors, indicating the universal effect of
Seemingly Unrelated information asymmetries. Firms overcome the lack
Regression (SUR) of adequate collateralisable firm assets in two
ways: by providing personal assets as collateral for
business debt, and by employing additional
external equity to finance research and
development projects
Studies adopting the “owner motivation/goals” approach – theoretical studies

McMahon and Theoretical paper Financial objective Propose that the SME financial objective function
Stanger (1995) function/utility theory should reflect kinds of enterprise-specific risk
arising from liquidity, diversification,
transferability, flexibility, control, and
accountability considerations. Conceptualisation
by conventional utility theory is presented
Cressy (1995) Theoretical paper Disutility associated with A model of borrowing is provided where loan capital is
control productive and increases the firm’s revenue, but
brings the business under the control of the bank.
Dynamic analysis identify “Movers” and
“Stayers.” For the “Movers,” borrowing increases
over time to a profit-maximising optimum; whereas
for the “Stayers” independence of control is
maintained but at the expense of non-growth
Studies adopting the “owner motivation/goals” approach – empirical studies
Cooley and Edwards US (131) Descriptive analysis of Financial objectives of firm Owners of small closely-held firms consider
(1983) primary (survey) data owners maximisation of net income as the most important
financial objective
Norton (1991) US (110) Descriptive analysis of Agency theory. Management perceptions of the tradeoffs involved in
B.12 Conclusion
primary (survey) data Signalling external financing will determine whether debt,
equity, or neither will be issued. The sum total of
these perceptions, beliefs, and conditions over time
form the firm’s present capital structure
Chaganti et al. US (903) Discriminant analysis of Signalling theory. Satisfaction with “economic need” drives the
(1995) secondary (survey) data Strategic management entrepreneur toward debt financing. Consistent
with signalling theory, entrepreneurs who are
bullish about their ventures seek equity financing
rather than debt financing. “Sweat equity” and
financial capital are substitutes. Entrepreneurs’
personal characteristics play a key role in capital
structure decision
Ang et al. (1995) US (692) Bivariate analysis of Agency theory In the absence of available business collateral, a
secondary (survey) data substantial proportion of SME owners are required
to pledge personal commitments to obtain business
loans. Firm owners who lack personal assets and
wealth to provide personal commitments are more
likely to experience credit rationing
Le Cornu et al. Australia (30) Analysis of interviews, Financial objective function Owner-managers’ objectives include: attention to
(1996) including Mann liquidity considerations, retaining control, and
Whitney tests maintaining independence
Kuratko et al. US Midwest Frequency analysis, Managerial attitudes and Investigates a set of goals which motivate
(1997) (234) confirmatory factor performance entrepreneurs to sustain their business development
analysis efforts. A four factor structure of goal statements is
developed; extrinsic rewards, independence/
175
autonomy, intrinsic rewards, and family security

(continued)
176

size)
Wright et al. (1997) UK (13) Case analysis Motivations of There are two types of serial entrepreneurs; venture
entrepreneurs repeaters (defensive reasons); and serial
dealmakers and organic serials (opportunistic).
Capital gain is less important the second time
around, and less exposure to risk is important.
Personal commitment is high.
Hamilton and Fox New Zealand Bivariate analysis on Pecking order theory Independence of the firm owner is the overriding
(1998) (185) primary (questionnaire) consideration in choosing source of financing,
data independent of size or age of the firm. No evidence
for a funding gap
Kotey (1999) New South Cluster analysis and Strategic objectives/ Owner-managers of higher leveraged firms were found
Wales (224) Manova personal values of firm to be less entrepreneurial than those of low/medium
owners leveraged firms
Giudici and Paleari Italy (46) Probit analysis on primary Pecking order theory. Respondents rely on personal finance, and secondly on
(2000) (questionnaire) data short term bank debt. They wish to maintain control
over firm activities and are willing to issue outside
equity only if new investors also provide non
financial competencies
Howorth (2001) UK (13) Case analysis Pecking order theory. For the majority of cases, the pecking order theory
applies only in truncated form. Both demand and
supply factors important, but demand side takes
preference. Where truncation occurs at long-term
debt firms are constrained, but not at external
equity
Poutziouris (2003) UK (922) Principal components Strategic objectives Four clusters of firm owner objectives are identified;
analysis; Cluster growth; survival-oriented; exit oriented, and
analysis; Chi-squared control oriented
analysis on
questionnaire data
Hogan and Hutson Ireland Descriptive analysis of Pecking order theory Internal funds are the most important source of funding
(2005) (117) primary (survey) data for NTBFs. Respondents prefer outside equity to
debt
Fitzsimmons and Australia Logistic regression Pecking order theory Only 5% of SMEs intend to sell equity. The primary
B.12 Conclusion
Douglas, (2006) (4,500) reasons include the firm owner’s intention to sell
the firm, and to fund growth. Intention to sell equity
is negatively related to family ownership
Studies adopting a combination of “owner motivation” and “firm” characteristic approaches

Cressy and Olofsson, Sweden (285) Univariate analysis of Pecking order theory Support for the pecking order theory. Control is the
(1997b) primary (survey) data important determinant. Owners of younger firms in
business services are willing to sacrifice control for
finance and added expertise
Jordan et al. (1998) South East Ordinary least squares and Strategy Competitive strategy is significant in determining
England weighted least squares capital structure, highlighting issues of risk,
(275) regression uncertainty, and information asymmetries. Support
for pecking order theory. Positive relationships
between turnover and risk, and debt levels may
evidence “distress” borrowing
Avery et al. (1998) US (1987 and Logistic regression on Personal commitment use Personal commitments are important for firms seeking
1993 NSSBF cross-sectional panel loans. Guarantees are more prevalent than
data)a SCF data collateral. Personal commitments are substitutes
(1989 1992 for business collateral. Personal collateral and
and 1995) personal guarantees are not substitutes
(continued)
177
178

size)
Romano et al. (2001) Australia (1,490) Principal components Modigliani and Miller Size, family control, business planning, and objectives
analysis propositions are positively associated with debt. External equity
Confirmatory factor Agency theory is considered by owners of large firms, young firms,
analysis Trade-off theory and owners who plan to achieve growth through
Structural equation Pecking order theory increasing profit margins. It is less likely to be
modelling considered by older family firms. The interplay
between multiple social, family, and financial
factors is complex
Coleman and Cohn US (4,637) Multiple regression analysis Modigliani and Miller Leverage is predominantly a function of firm
(2000) propositions characteristics (rather than owner characteristics).
Pecking order theory SME leverage is a function of size, age,
profitability, organisation structure, and
willingness or ability to supply collateral
Berggren et al. Sweden (281) Structural equation Control aversion Support for control aversion and pecking order theory
(2000) modelling
Basu and Parker UK (195) Heckman’s two stage Family finance After bank finance, borrowing from family and friends
(2001) sample selection model is the chief source of funds for new business start-
ups in many countries, including the UK
Cassar (2004) Business Tobit, logit, and ordinary Trade-off theory The larger the start-up, the greater the percentage of
longitudinal least square regressions Pecking order theory debt employed. Where a firm has no tangible
survey (292) on cross-sectional panel assets, informal networks are important. Start-ups
data with the intent to grow are more likely to use bank
financing. Personal characteristics of the firm
owner are unimportant
a
Denotes source of data
Appendix C
Sectoral Classification of Sample Frame by
NACE Codes
Two digit Sectoral classification Number Proportion of

NACE code of firms total sample(%)
Metal manufacturing and engineering
21/22 Metal ore and metal production 3 0.40
31 Metal articles 17 2.40
32 Mechanical engineering 24 3.40
33 Office and data processing machinery 40 5.70
34 Electrical engineering 15 2.10
35 Manufacture of motor parts and vehicles 4 0.60
36 Other means of transport manufacture 1 0.10
37 Instrument engineering 10 1.40
38 Computer hardware and related products 6 0.90
120 17.09
Other manufacturing
26 Man-made fibres industry 3 0.40
25 Chemical industry 12 1.70
39 Medical devices 6 0.90
41 Food processing 45 6.40
42 Drink and tobacco industry 4 0.60
43 Textiles 4 0.60
44 Leather 1 0.10
45 Clothing and footwear 17 2.40
46 Timber and wooden furniture 20 2.80
47 Paper, printing, and publishing 45 6.40
48 Rubber and plastics processing 15 2.10
49 Other manufacturing 58 8.30
230 32.76
40 Computer software development and services 88 12.50
Distribution, retail, hotels, and catering

61 Wholesale distribution 35 5.00
63 Marketing 18 2.60
(continued)
179
180 Appendix C Sectoral Classification of Sample Frame by NACE Codes
(continued)
Two digit Sectoral classification Number Proportion of
NACE code of firms total sample(%)
64 Retail distribution 34 4.80
66 Hotels and catering 46 6.60
133 18.9
Other services
76 Supporting services to transport 3 0.40
77 Travel/Freight agents and warehouses 12 1.70
78 Communications 10 1.40
94 Research and development 3 0.40
95 Medical and veterinary services 3 0.40
96 Other general services 24 3.40
97 Recreational and cultural services 2 0.30
105/106 Building industry professionals 8 1.10
72 Other land transport 2 0.30
75 Air transport 1 0.10
68 9.69
Other
01 Agriculture 17 2.40
03 Fishing 4 0.60
51 Building and civil engineering 42 6.00
63 9.0
Total 702
Appendix D
Supplementary Tables Referenced in Chapter 4
Supporting tables presenting results of cross-tabulations, chi-square tests, and

directional measures.
Table D.1 Crosstabulation of sector with “I issue external equity only as a last resort” (% of
respondents)
Sector I issue external equity only as a last resort (n ¼ 279)
Strongly Agree Neither agree Disagree Strongly Total
agree nor disagree disagree
Metal manufacturing 5 5.7 2.9 1.4 0 15
and engineering
Other 5.7 7.9 5.0 1.4 0.4 20.4
manufacturing
Computer software 2.2 5.0 6.1 4.7 0 17.9
development and services
Distribution, retail, hotels, 8.2 8.6 8.2 2.9 0.4 28.3
and catering
Other services 2.9 2.5 1.4 2.2 0.4 9.3
Other 3.2 3.2 2.5 0 0 9.0
Total 27.2 33 26.2 12.5 1.1 100
Table D.2 Chi-square and directional measures for crosstabulation of sector with “I issue exter-
nal equity only as a last resort”
Value Approximate
significance
Pearson chi-square 29.14 0.085*
Goodman and Kruskal tau Industry dependent 0.020 0.125
“Issue equity” dependent 0.024 0.137
Uncertainty coefficient Industry dependent 0.034 0.042**
“Issue equity” dependent 0.042 0.042**
**, * Statistically significant at the 95% and 90% levels of confidence respectively
181
182 Appendix D Supplementary Tables Referenced in Chapter 4
Table D.3 Crosstabulation of sector with “A long term bank loan would suit my investment
needs” (% of respondents)
Sector “A long term bank loan would suit my investment needs”
(n ¼ 283)
Metal manufacturing and 1.4 5.7 4.2 3.2 0.7 15.2
engineering
Other manufacturing 3.2 8.1 6 2.5 0.7 20.5
Computer software development 0.7 4.9 4.6 6 1.8 18
and services
Distribution, retail, hotels, and 5.7 9.5 6.4 4.6 1.4 27.6
catering
Other services 1.4 1.4 3.2 3.2 0.4 9.5
Other 1.4 4.6 1.1 1.1 1.1 9.2
Total 13.8 34.3 25.4 20.5 6 100
Table D.4 Chi-square and directional measures for crosstabulation of sector with “A long term
bank loan would suit my investment needs”
Value Approximate
significance
Pearson chi-square 29.9 0.071*
Goodman and Sector dependent 0.021 0.088*
Kruskal tau “A long term bank loan would suit my 0.029 0.038**
investment needs” dependent
Uncertainty Sector dependent 0.032 0.05**
coefficient “A long term bank loan would suit my 0.037 0.05**
investment needs” dependent
**Statistically significant at the 95% and 90% levels of confidence respectively
Table D.5 Chi-square and directional measures for crosstabulation of financial requirement with
perception of difficulty in raising additional finance
Funding requirement Pearson chi- Goodman and Uncertainty
square Kruskal tau coefficient
(symmetric)
Debt now 2.37 0.012 0.010
(0.124) (0.125) (0.125)
Debt in the next 0.017 0.000 0.000
3 years (0.896) (0.896) (0.896)
Equity now 36.43 0.193 0.161
(0.000***) (0.000***) (0.000***)
Equity in the next 3 years 35.33 0.190 0.174
(0.000***) (0.000***) (0.000***)
***Statistically significant at the 99% level of confidence
Appendix D Supplementary Tables Referenced in Chapter 4 183
Table D.6 Crosstabulation of sector with perception of difficulty in raising additional external
finance
Sector Perceived difficulty in raising additional
external finance (% of respondents) (n ¼ 227)
Metal manufacturing and engineering 4
Other Manufacturing 2.6
Computer software development and services 7
Distribution, retail, hotels, and catering 2.6
Other services 1.3
Other 2.6
Total (n ¼ 46) 20.1
Table D.7 Chi-square and directional measures for crosstabulation of sector with perception
of difficulty in raising additional external finance
Value Approximate
significance
Goodman and Sector dependent 0.016 0.002***
Kruskal tau “Perception of difficulty in raising additional 0.065 0.011***
finance” dependent
Uncertainty Sector dependent 0.019 0.012***
coefficient “Perception of difficulty in raising additional 0.064 0.012***
finance” dependent
Table D.8 Crosstabulation of ownership structure with desire to retain control of the firm
Private limited firm – Private limited firm –
shares traded within shares more widely
the family (%) traded (%)
Strongly agree or agree with the 88 50
statement “Retain a majority
shareholding (>50%) in the business
for the founder(s)” (n ¼ 284)
Table D.9 Crosstabulation of sector with desire to retain control of the firm
Sector “Retain a majority shareholding (>50%) in the business for
the founder(s)” (n ¼ 284)
Metal manufacturing and 7.8 5 1.4 0.7 0.4 15.2
engineering
Other manufacturing 7.4 9.2 2.8 1.1 0 20.6
Computer software development 4.3 2.8 7.8 2.1 0.7 17.7
and services
Distribution, retail, hotels, 14.5 8.2 4.3 1.4 0 28.4
and catering
Other services 4.6 2.5 1.4 0.4 0 8.9
Other 4.3 2.5 1.8 0.4 0.4 9.2
Total 42.9 30.1 19.5 6 1.4 100
Table D.10 Chi-square and directional measures for crosstabulation of sector with desire to retain
control of the firm
Value Approximate
significance
Kruskal tau “Desire to retain control of the firm” dependent 0.050 0.000***
coefficient “Desire to retain control of the firm” dependent 0.059 0.002***
Table D.11 Crosstabulation of firm age with “Banks understand my business” (% of respondents)
Firm age “Banks understand my business” (n ¼ 289)
(years) Strongly Agree Neither agree Disagree Strongly Total
<5 0 2.1 1 1.4 0.3 4.8
5–9 1.4 4.8 5.5 4.2 1.7 17.6
10–14 0.7 3.8 5.5 2.1 0.7 12.8
15–19 0.3 4.5 4.2 1.7 0 10.7
20–29 1.7 9 6.2 4.8 0.3 22.1
>30 3.1 15.6 8.3 4.5 0.3 31.8
Total 100
Table D.12 Chi-square and directional measures for crosstabulation of firm age by “Banks
understand my business”
Value Approximate
significance
Pearson chi-square 24.43 0.224
Goodman and Kruskal tau Firm age dependent 0.020 0.098*
“Banks understand my business” 0.021 0.256
dependent
Uncertainty coefficient Firm age dependent 0.026 0.195
“Banks understand my business” 0.032 0.195
dependent
*Statistically significant at the 90% level of confidence
Table D.13 Crosstabulation of sector with “Banks understand my business” (% of respondents)

Sector “Banks understand my business”
Metal manufacturing and 0.7 7.7 4.5 2.1 0.3 15.3
engineering
Other manufacturing 1.7 8.4 5.9 4.5 0.3 20.9
Computer software development 0 5.2 6.3 4.9 1.4 17.8
and services
Distribution, retail, hotels, 3.5 13.6 8.4 2.4 0.3 28.2
and catering
Other services 0.7 3.5 2.8 2.1 0 9.1
Other 0.7 1.4 2.8 2.8 1 8.7
Total 7.3 39.7 30.7 18.8 3.5 100
Appendix D Supplementary Tables Referenced in Chapter 4 185
Table D.14 Chi-square and directional measures for crosstabulation of sector with “Banks
understand my business”
Value Approximate
significance
Pearson Chi-square 35.9 0.016**
Goodman and Kruskal tau Sector dependent 0.027 0.007***
“Banks understand my business” 0.029 0.030**
dependent
Uncertainty coefficient Sector dependent 0.040 0.006***
“Banks understand my business” 0.051 0.006***
dependent
***, ** Statistically significant at the 99% and 95% levels of confidence respectively
Table D.15 Crosstabulation of sector with the financial objective “Maximise potential selling
value of the firm” (% of respondents)
Sector “Maximise potential selling value of the firm”
Primary Secondary Tertiary
objective objective objective
Metal manufacturing and engineering 1.1 5.1 1.8
Other manufacturing 2.2 2.9 3.6
Computer software development and services 7.9 2.9 1.1
Distribution, retail, hotels, and catering 4 3.6 4
Other services 2.5 1.4 2.5
Other 2.5 1.1 0.4
Total (n ¼ 277) 20.2 17 13.4
Table D.16 Chi-square and directional measures for crosstabulation of sector with the financial
objective “Maximise potential selling value of the firm”
Value Approximate
significance
Kruskal tau “Maximise potential selling 0.047 0.000***
value of the firm” dependent
coefficient “Maximise potential selling 0.058 0.000***
value of the firm” dependent
*** Statistically significant at the 99% level of confidence
Table D.17 Crosstabulation of sector with the financial objective “Maximise net income/profit”
(% of respondents)
Sector “Maximise potential selling value of the firm”
Primary Secondary Tertiary
objective objective objective
Metal manufacturing and engineering 11.8 1.8 2.1
Other manufacturing 15.4 2.1 1.8
Computer software development and services 6.4 5.4 2.9
Distribution, retail, hotels, and catering 13.9 9.6 3.9
Other services 5.4 2.9 0.4
Other 5 2.1 1.1
Total (n ¼ 277) 57.9 23.9 12.2
Table D.18 Chi-square and directional measures for crosstabulation of sector with the financial
objective “Maximise net income/profit”
Value Approximate
significance
Kruskal tau “Maximise net income/profit” 0.062 0.000***
dependent
coefficient “Maximise net income/profit” 0.074 0.001***
dependent
*** Statistically significant at the 99% level of confidence
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Index
A Bureau van Dijk Amadeus database, 34

Accessing new markets, 85 Business angels, 32, 35–38, 40
Added business risk, 57, 84, 99, 108 Business closure rates, xvii, 142
Adjusted R square, 60 Business Expansion Scheme (BES),
Adverse selection, 88, 114, 151, 153 17, 112
Age bias, 128 Business World ‘Next 1,500’ list, 120, 127
Alternative Investment Market (AIM),
20, 148
Ang, J.S., 12, 42, 57, 70, 122, 138, 143, C
150, 152, 155, 165, 169, 175 Capital structure theories, 14, 137, 138, 157
Asset-based lending techniques, 39, 41, agency theory, 39, 59, 62, 108–110, 139,
43, 56, 59, 67, 68, 70, 84, 109, 112, 149–154, 157, 167–175
113, 153, 158, 160 Cassar, G., 14, 51, 52, 57, 59–61, 88, 147,
Asset substitution effect, 150 156, 157, 159, 161, 163, 170, 178
Australia, viii, 10, 14, 56, 157–159, 161, Categorical form, 48, 122
167, 170, 171, 174, 177, 178 Central limit theorem, 28, 30, 47
Autonomy aversion, 165 Closely held firms, 55, 57, 59, 70, 87, 88,
Aversion to external equity, 80, 87, 96, 115, 170
101, 102, 115, 148 Collateral, provision of viii, xix, 16, 17,
Avery, R.B., 42, 57, 59, 122, 143, 152, 176 25–28, 33, 39–43, 46, 48–50, 56, 58,
59, 67–70, 80, 82, 84, 88, 90, 91, 102,
B 106, 108, 109, 111–114, 116, 140, 146,
Bankruptcy, 142, 143, 153, 156, 162. 149, 152–154, 156, 159, 160, 164, 168,
See also Personal bankruptcy 170, 171, 173–175
Basel II accord, 109, 112, 113, 154 fixed assets of the firm, 41–43, 49, 56, 117
Berger, A.N. and Udell, G.F., viii, 10, 23, other guarantors, 33, 40–43, 109
26–28, 31–33, 35, 36, 38–40, 42, 43, personal assets of the firm owner, 33,
53, 56, 57, 68, 88, 146, 148, 151–154, 41–43, 58, 59, 69–71, 116, 130
164, 168 see also Asset-based lending techniques
Birch, D., 1, 2 Combined corporate income tax rates,
Bolton Committee, 8, 9 xvii, 141
British Venture Capital Association Companies Registration Office (CRO), 119
(BVCA), 13 Contact mode, xxi, 126
205
206 Index
Control and managerial independence. See Due diligence, 148, 151

Firm owners’ goals Dummy variable approach, 63, 65
Control and ownership, 55 Dummy variables, 63, 65, 160
Control aversion, xvii, 87, 143, 144, 178 Dun and Bradstreet database, 119,
Convertible securities, 151 120, 155
Corporate finance, 14, 23, 25, 78, 101, 122,
137, 145, 148, 150, 155, 156, 165
Corporate income tax rate, 141 E
Cost of capital, 23, 90, 137, 138 Economic contribution, vii, 3, 5, 11, 20
Credit facilities, 157 Employment, 1–7, 10, 15, 18, 20, 105,
Credit-market efficiency, 109 127
Credit rationing, 12, 13, 147, 152, 173 Enterprise Ireland, 18, 120, 125
Credit scoring, 152 Enterprise Observatory Survey, 130, 132
Credit squeeze, 100, 102 Epistemological orientation, 118
Cressy, R., 2, 13, 25, 56, 57, 70, 79, 86, Equity gap, 15, 148
97, 109, 115, 119, 122, 128, 142–144, Esperanca, J.P., 13, 36, 51, 56, 57, 61, 89,
146–148, 164, 174, 177 143, 157–159, 161, 162, 170
Cross-sectional, 23, 24, 34, 36, 65, 118, ESRC Small Business Initiative, 8
167–171, 173 EU Administrative Burdens Exercise, 111
Culliton report, 15 Evans, D.S. and Jovanovic, B., 31, 33, 42,
Curran, J. and Blackburn, R.A., viii, 55, 164
119, 120, 127 Excessive optimism, 146
Expenditure on research and development,
117, 130–131
D Export activity, 131–135
Data collection, 117–118 External financing requirement, 78, 81,
Deadweight and displacement effects, 112, 85, 130, 160
113
Debt-equity ratio, 150
Debt-tax shield, 93, 99–100, 123, 141, F
161, 162 Fairlie, R.W., 31, 33, 55, 164
interest tax shields, 139, 140 Financial bootstrapping, 94, 130
Definitions, 8 Financial distress, 94, 137, 139–143, 151,
De Meza, D. and Webb, D.C., 12, 112, 147 152, 162, 177
Department of Enterprise, Trade and Financial growth life cycle model, 24, 26,
Employment Equity capital surveys, 15 28, 34–38, 42, 43, 53, 55, 59, 110, 115,
Dependent variables, xix, xx, 35, 45–48, 50, 168, 172
53, 60, 65, 155, 156 Financial slack, 93, 95, 97, 100–102
Descriptive statistics, xx, 46, 47, 49 Financial statement lending, 112, 152, 154
Desire for control, 87, 164, 165 Financiers’ assessment of risk, 83
Diamond, D.W., 27, 33, 38, 41, 43, 89, 91, Financing preferences, vii, 14, 77, 78, 81,
102, 153, 157 85–86, 93, 101, 102, 106, 115, 118, 123,
Dillman, D., 118, 123, 124, 126 127, 147
Discouraged borrower’s theory, 80 Firm and industry effects, 45
Distribution statistics, xx, 48, 49 Firm characteristics, 14, 114, 117, 156, 164,
Disutility of firm owner, 153 166, 167
Dividend policy, 145 Firm continuum, xvii, 27
Dublin City University, viii, 123 Firm owner’s goals, 82
Index 207
business goals, 106, 118, 123, 127, Intergenerational transfer, 165

163, 164, 166 Inter-industry differences, 33, 62, 63,
financial objective function, 115, 160, 167
165, 174 Internal constraint on firm growth, 84–85
Flexible production technologies, 142 Invest Northern Ireland, 18
Fluck, Z., 26, 27, 33, 34, 39, 43, 51, Irish corporate tax rate, 110, 111, 141
55, 57, 68, 158, 164, 168 Irish Enterprise Exchange (IEX), 20, 148
Foreign Direct Investment (FDI), viii, 2, 14 Irish Small and Medium Sized Enterprises
Freepost, 124, 126 Association (ISME), 120
Future research, 106, 110–111
J
G Jones-Evans, D., 16
Government policy, 15, 84, 85 Journals, SME specific, 12
Government sponsored surveys, 11, 15
Gross value added, 2, 5
Growth aspirations, 164 K
Kinsella, R., 15, 119
Kolmogorov-Smirnov test, 28, 48, 49
H Kruskal Wallis Chi-Squared test, 28
Hall, G., vii, viii, 12, 33, 45, 47, 51,
52, 56, 57, 62, 63, 65, 119, 120,
147, 155–161, 169 L
Hanks, S.H., 24, 28 Lease finance, 34
Heteroskedasticity, 61–62 Levene statistic, 28
Hogan, T. and Hutson, E., 15, 16, 26, Life cycle theory of the firm, 24–26
57, 58, 66, 68, 79, 81, 87, 89, 92, Likert questionnaire items, 77, 78, 101,
147, 148, 177 105, 110
Longitudinal data, 34, 118
Long-term debt, 16, 29–33, 37, 38, 43, 45,
I 47, 48, 50, 54, 56, 57, 59–61, 63–65,
Improvements in efficiency, 66 67, 70, 80, 81, 89, 90, 101, 102, 107,
Independent variables, xi, xx, 43, 46, 48–50, 109, 115, 157–159
53, 55, 60, 61, 63, 66, 156, 158 as a dependent variable, 45–48, 50–52
distribution statistics of, 49 sources of, 17
multicollinearity test, 50, 53 use of, 33, 43, 56, 63
Pearson correlation coefficients, 53 wilingness to employ, 107, 108, 115, 148
Indifference curve, 143 see also Discouraged borrower’s theory
Industrial Development Authority, 120, 123 and Maturity matching
Information asymmetries, 33, 38, 39, 41–43, Loss of control, 25, 26, 84, 95–97,
70, 78, 89, 91, 98, 107, 112, 115, 145 148, 168
Initial capitalisation, 42, 147
Initial public offering, 26, 92, 148
Innovation, 2, 6, 7, 20, 58, 167 M
Intangible assets, 45, 66, 69, 70, 89, 90, 102, MacMillan Committee, 11, 13
109, 139, 160 Management skills, 85, 97, 112, 113
Interdisciplinarity, 11 Management training, 112
Interest rates, 94, 97, 99, 100, 102, 107, 110, Managerial independence, 26, 86–88, 95,
114, 147, 154, 168 96, 107, 115, 148, 164
208 Index
Managerial risk aversion, 145, 149 O

Marginal utility, 143 One-way Anova, 28–30, 34–36, 38–40,
Market sentiment, 83 43, 47, 65, 94, 106
Market timing model, 144–146 One-way Anova post-hoc analysis, 35–36
timing theory, 97, 146 Operating risk, 169
Maturity matching, 59, 109, 116, Oppenheimer, A.N., 125
159, 171 Other guarantors, 33, 40–43, 109
Methodology, 43, 45, 77, 118, 124, Overtrading, 25
127, 166 Owner characteristics, 23, 52, 154, 155,
Michaelas, N., vii, 14, 25, 56, 57, 60, 61, 163–165, 177
66, 79, 110, 111, 122, 142, 143, 147, Ownership structure, 183
148, 164 Owner’s reputation and self-esteem, 143
Modified pecking order, 106, 144,
145, 147
Modigliani, F. and Miller, M.H., 23, P
137–139, 144, 170, 178 Paired-samples correlations, xix, 37, 41
Monopoly-lender theory, 27 Paired-samples t test, 36, 41, 42
Moral hazard, 34, 39, 68, 80, 84, 91, Pearson correlation coefficient, 50
108, 150–154, 157, 158 Pecking order theory, 33, 37, 39, 42,
Mulcahy, D., 15, 18, 32, 82 55–59, 67, 79–82, 84, 87, 94, 95, 97,
Multicollinearity, 46, 50–53 101, 106–108, 111, 137, 144–148,
Multimode approaches, 124 157, 158, 161, 167–174, 176–178
Multinational enterprises, viii, 7 Penrose, E.T., 24
Multivariate regression models, 45, 63, Perceived financing constraint, 82
64, 155 Perceptions of funders, 86
Multivariate regression results, 53–59 Personal assets of the firm owner, 33, 40,
Myers, S., 31, 42, 55, 57, 59, 60, 80–82, 41, 48, 57, 59, 69, 70, 108, 109, 112,
84, 87, 90, 94, 106, 111, 115, 137, 114, 116
139, 140, 145, 147 Personal bankruptcy, 143
Personal funds of the firm owner, xx, 31, 33,
41, 46, 54, 55, 57–59, 62, 64, 65, 67, 70,
N 106, 109, 114, 130, 164
NACE codes, 48, 123, 129, 179–180 personal savings and ‘f’ connections, 31
National Directory Database, 120 personal savings of the firm owner, 25,
National Economic and Social Council 38, 106
(NESC), 14, 15 Personal guarantees, 17, 42, 80, 111, 177
National Survey on Small Business Pilot study, 123, 125
Finances (NSSBF), 26, 118 Plato Ireland, 120
New firm formation, 7, 15, 39 Policy implications, 111–113
New Technology Based Firms (NTBFs), Political considerations, 148
15, 25, 88, 96 Population listings, 119
Non-debt tax shields, 162, 171, 173 Preferences of firm owners, 21, 26, 79
Non-executive directors, 96–98 Previous studies, xxi, 63, 111, 160, 164,
Non parametric techniques, 30, 163 164–166
Non-response bias, 125 Principal-agent relationships, 138, 149
North American Industry Classification Profile of respondents, 127
System Codes (NAICS), 10 Propensity for risk, 59, 155, 164
Numeraire, 63, 65 Property rights, 149, 153
Index 209
Provision of collateral, 39, 42, 46, 56, 67, overreliance on, 90, 102
90, 108 use of, 33, 36, 43, 56
Proxy variable, 60, 91, 123, 143, 156, 157, Signalling mechanism, xxi, 78, 93, 95,
159, 162, 165, 171 97–99, 101, 102, 106–108, 115, 123,
Publicly Listed Companies (PLCs), 98, 138 137, 139, 144–149, 165, 175
Small business credit scoring lending, 152
Small Firms Association (SFA), 120
Q Sogorb Mira, F., 13, 45, 52, 56, 60, 61, 99,
Quadratic variable, 55 110, 138, 141, 147, 155–162, 171, 173
Quasi-equity, 25, 33, 39, 70, 153 Sources of financing
Questionnaire instrument, 79, 111, employed by respondents, xix, xx, 29,
120–123, 125–127 36, 37, 65
finance from friends and family, 25, 29,
31, 37, 53, 70
R
personal funds of firm owner, 31, 41,
Radcliffe Committee, 11
46, 54, 58, 62, 64, 65, 70, 106,
Recall bias, 38, 42
114, 130
Regional development, 2, 7, 20
retained profits, 25, 29, 31, 33, 37, 43,
Relationship lending, 108, 152–154
46, 50, 55, 58, 62, 65, 84, 85,
Reputation effects, 27, 41, 91, 102, 107,
87, 89, 101, 107, 115, 116, 130,
108, 116, 153
158, 162
Research objectives, 21, 114
venture capital, 17, 37
Respondents’ perception of funders, xx,
Sources of venture capital in Ireland, 19
88, 89
Staging capital investment, 151
Response rate, xxi, 28, 111, 122–127
Statistical methodology, 43, 45, 166
Results of seemingly unrelated regression
Statistical significance, 28, 36, 59–61, 63,
models, 66–69
73–75, 114, 163
Retrievability effect, 124
Stiglitz, J.E. and Weiss, A., 12, 88, 147,
Revenue commissioners, 119
151
Storey, D.J., 1, 2, 4, 8–11, 13, 15, 58, 80,
S 84, 90, 109, 114, 119, 121, 125, 128,
Sample frame, 117–121, 125, 179–180 131, 149, 151–153, 160, 164, 165
Schumacher, E.F., v, 1 Strategic and managerial choice, 14
Secondary sources of data, 118 Structural equation modelling, 156
Sectoral acronyms, xx, 49 Succession in family firms, 111
Sectoral classification, 129 Survival rates, 110, 146
Sectoral differences, 41, 42, 46, 49, 56, Survivorship bias, 110, 121
57, 61–63, 65, 66, 67, 69, 78, 85, 92,
93, 102, 108–110, 117, 128, 131
Seed and venture capital programme, 18 T
Seemingly unrelated regression model, Target debt ratios, 139, 140
results, 71–76 Tax incentives, 111
Shannon Free Airport Development Tax shield, 78, 110, 139–143, 167
Company (SFADCo), 120 Tax system, 139
Short-term debt, 25, 33, 47, 51, 54, 64, 89, Tolerance values, 53
168, 169 Trade credit, 25, 26, 34, 90
as a dependent variable, 47, 48, 50–52, Trade-off theory, 95, 97, 99, 110, 137,
60, 65 139–144, 147, 161, 166
210 Index
Transaction costs, 157 V

Trinity College Dublin, viii, 123 Variance Inflation Factors (VIF), 50
Truncated pecking order, 82, 84, 94, Venture capital investment, 13, 18, 19, 90.
95, 101, 108, 115 See also sources of venture capital in
Ireland and Sources of financing
U W
Údarás na Gaeltachta, 120 Wealth constraints, 164
Undercapitalisation, 25, 142, 164, 167 Welch and Brown-Forsythe statistics, 30
Underinvestment, 12, 81, 90, 94, 102, White test, 54, 61, 62
107, 110, 114, 144, 147 Wilson Committee, 11
Underpricing, 148
United Kingdom Survey of Small and Z
Medium-sized Enterprises’ Finances Zellner’s (1962) Seemingly Unrelated
(UKSMEF), 118 Regression (SUR), 46, 63

Research Methodology and Profile of Respondents: Appendix A

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Research Methodology and Profile of Respondents: Appendix A

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Appendix A

Research Methodology and Profile

A.2 Data Collection

A.3 Selection of the Sample Frame

Survey research is conducted to estimate the distribution of characteristics in a

accounting information provided in a number of cases is limited, as some firms are

annually, measured by turnover. A list of the “Next 1,500” is also compiled

A.4 Development of the Questionnaire Instrument

Data for this study was collected by means of a self-administered questionnaire

Table A.1 Database detail and survey response rate

instruments employed in corporate finance research (Norton 1991; Graham and

employees); NACE codes (sector); or previous studies (age categories as used in

A.5 Elements Incorporated to Improve Response Rate

The cover page of the questionnaire instrument provided a description of the

Table A.2 Response rate by mode of delivery

to compare data of early respondents with that of late respondents, as Oppenheimer

A.6 Piloting and Testing the Questionnaire Instrument

A preliminary version of the questionnaire instrument was circulated among aca-

Table A.3 Response rate by contact mode

A.7 Profile of Respondents

A.8 Age Profile of Respondents

Because of the lower bound of 20 employees imposed in it’s composition, micro

Table A.4 Age and industry profile of respondents

A.9 Sectoral Profile of Respondents

A.10 Size Profile of Respondents

Table A.5 Size profile of respondents defined by employees and turnover

A.11 Respondents’ Expenditure on Research and Development

A requirement for additional external financing is generally related to the presence

Table A.6 Reported R&D expenditure of respondents as a per-

A.12 Export Activity of Respondents

Table A.8 Turnover generated from exports by Irish SMEs in 2005

Supporting Tables Presenting Results of Crosstabulations, Chi-square Tests, and

Table A.9 Crosstabulation of age by sector (% of respondents)

Table A.11 Crosstabulation of age by turnover (% of respondents)

Table A.13 Crosstabulation of turnover by sector (% of respondents)

Table A.15 Crosstabulation of R&D expenditure by sector (% of respondents)

Table A.17 Crosstabulation of export revenue by sector (% of respondents)

B.2 The Modigliani and Miller Propositions

Recognising that the assumption of perfect markets was unrealistic, in particular

B.3 Static Trade-Off Theory

Optimal Capital Debt

Fig. B.1 The static-trade off theory of capital structure

0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00

Fig. B.2 Combined corporate income tax rates (%) 2008

Macroeconomic factors have a significant influence on the value of debt-tax

B.4 Application of Trade-Off Theory to the SME Sector

quoted firms. This may be explained by consideration of two factors central to

Fig. B.3 Business closure rates by time trading

conditions, which are typically exacerbated by the absence of hedging instruments

Fig. B.4 Effects of control aversion on the amount of borrowing

B.5 Asymmetric Information and Signalling Theories

B.6 Application of Asymmetric Information and Signalling

B.7 Agency Theory

B.8 Application of Agency Theory to the SME Sector

“conflicts in perception regarding the intentions of the entrepreneur, the heightened

single most important determinant in inducing a bank to extend a loan. A substan-

B.9 Empirical Evidence of Determinants of SME Capital

As evidenced from the foregoing analysis of capital structure literature, empirical