Are There Non-linear Effects of Banking Relationships and Ownership Concentration on Operational Performance? Empirical Evidence from Portuguese SMEs Using Cross-section Analysis and Panel Data

Antonio Pedro Soares Pinto,Mario Gomes Augusto

doi:10.5430/ijfr.v5n4p67

Abstract

This paper provides new evidence for the relationship between the stability of the banking relationship, ownership concentration and operating profitability, supporting non-linear effects between those variables in the context of small and medium enterprises (SMEs). From a sample of 4,163 Portuguese SMEs and cross-section data and panel data, we found evidence for a U-shaped quadratic relationship between the stability of the banking relationship and operational performance. This result indicates that the consolidation of new banking relationships, the difficulties experienced by SMEs in overcoming the problems of adverse selection and moral hazard reflect negatively on their operating profitability. However, when the banking relationship is solidified, and banking institutions acquire information, supervision and monitoring costs decrease, credit constraints are lower and contractual conditions are tailored to the needs of the company, with positive impacts on operating profitability. In turn, the quadratic specification established between ownership concentration and operating profitability suggests that the expropriation hypothesis prevails for low levels of control rights and the supervision hypothesis prevails for high levels.

Highlights

In economies where bank financing is important in financing enterprises in general and small and medium enterprises (SMEs) in particular, understanding how the stability of the banking relationship may affect access to credit as well as its cost and profitability is of particular importance both for businesses as well as for conducting economic and fiscal policy in these economies (Fazzari et al, 1988)
In this study, using a sample of 4163 SMEs, cross-section and panel data, additional empirical evidence is provided for the effect of the stability of the banking relationship and ownership concentration on operational performance
Our empirical analysis focuses on the Portuguese SMEs, an economy where these companies represent over 99.5% of business units and where the banking system plays a central role in financing these businesses units

Summary

Introduction

In economies where bank financing is important in financing enterprises in general and SMEs in particular, understanding how the stability of the banking relationship may affect access to credit as well as its cost and profitability is of particular importance both for businesses as well as for conducting economic and fiscal policy in these economies (Fazzari et al, 1988). SMEs are important in terms of economic activity, employment and innovation in most countries (Behr et al, 2013). Stability and development of the banking relationship in a credit market characterized by information asymmetries may be an important competitive advantage both for SMEs, heavily dependent on bank credit, and for the financing bank. The financing bank reduces information asymmetry insofar as it appropriates private information over the course of the relationship, and SMEs see the possibility of improving medium-term funding conditions in quantity and price in that reduction (Vigneron, 2001, Cánovas and Solano, 2007, Shimizu 2012, among others). The relationship the bank has with the company, expanded and consolidated with its stability and duration, gives it greater knowledge and an improved ability to oversee credit agreements (Udel 2008, Behr et al, 2013). It becomes possible to increase the availability of credit, offer services that will best meet the needs of the company, gradually decrease the risk premiums and fund projects that may not be viable in the short term, but may be so in the medium and long term (Boot, 2000, Dass and Massa, 2011)

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