Capital structure and small public firms

Abstract

Most analyses of capital structure, from both a theoretical and an empirical viewpoint, focus on large corporations. As a result of data-availability problems, empirical studies deal with large corporations. Theoretical frameworks typically use illustrations and casual empirical evidence involving large firms. Only limited amounts of research focus on small, growing, entrepreneurial corporations and the factors affecting the capital structures of these firms. Much of current theory in capital structure deals with factors that are not easily and objectively quantified by outside researchers. These factors include items such as expected bankruptcy costs, information asymmetries between management and the financial marketplace, agency costs of monitoring management, and managerial risk preferences. This paper reports on a survey sent to over 400 small, high-growth corporations. Questions on the survey were derived from various strands of the theoretical financial literature on capital structure. Over 27% of the surveys were completed and returned, and give insight into the motivations and preferences of chief financial officers from over 100 small, high-growth corporations. Examination of the responses shows that, contrary to financial theory, factors dealing with bankruptcy costs, agency costs, and information asymmetries play little, if any, major role in affecting capital structure policy. Rather, the responding financial officers seem to follow a “pecking order” in financing their firm's needs (use internal cash as much as possible, issue debt if necessary, issue equity only as a last resort), while being concerned with market conditions and their own preferences. The following are implications of these findings. First, financial theory, which is more and more focusing on “micro” factors while still theorizing efficient “macro” markets, may be incorrectly ignoring the effect that management risk perceptions and preferences play in making capital structure decisions. Thus, additional work is necessary to include the management in theories of capital structure. Second, this survey allows outsiders to peer inside the managerial black box and gain insight into the factors that motivate and impact capital structure decisions. It provides an empirical basis to help determine which influences are important. Third, managers of entrepreneurial firms and investors in venture capital can compare their own beliefs, perceptions, and motivations against the mean results obtained from our sample of high-growth firms.