SMEs' diversification of financing sources: Strategy or desperation?

Abstract

AbstractThe paper's objective is to provide a large sample evidence on small and medium enterprises' (SMEs) financing source diversification patterns. We use the large World Bank Enterprise Survey (WBES) sample of SMEs from 135 developing and emerging economies. We find that the extent of financing source diversification is significantly affected by firm‐specific and country‐specific characteristics. Commonly, (unconstrained) SMEs specialise their financing in retained earnings. However, SMEs experiencing financial constraints often rely on diversified financing sources. We provide theoretical justification and empirical evidence of a quadratic relationship between financial constraints and financing source diversification: SMEs experiencing a moderate degree of financial constraints use the most diversified sources of financing. This finding, combined with the evidence that financially unconstrained SMEs use fewer financing sources, suggests that diversification of financing sources by SMEs is a strategic choice based on the optimal complementarity of financing sources achieved through the credit multiplier channel.