Investment and financing for SMEs with bank-tax interaction and public-private partnerships

Abstract

In this paper, we consider a small- and micro-sized enterprise (SME) with assets-in-place invests a project. Especially, we assume that the fund needed by the investment are shared by the government’s direct investment through public-private partnerships (PPPs) and the bank-tax interaction (BTI), which is a financial innovation instrument to solve the financing problem encountered by the SMEs. We address the pricing of corporate securities and optimal investment strategies. By providing a comparison with the pure private lending, we discover that the BTI makes the investment much cheaper and more attractive, and therefore mitigates the problem of under-investment in unstable markets. In addition, the BTI can increase the total firm value, reduce the leverage ratio and bankruptcy probability. The credit line of the BTI contract increases with the factors that influence the loan structure of the SME, such as the volatility, the tax rate, the investment cost sharing and the credit multiple. Most importantly, there exists an optimal investment cost sharing, such that the agency cost between SMEs and the government reaches zero due to the direct investment through PPPs.