Articles from Cass Knowledge

Capital Structures of Small Family Firms in Developing Countries

This study assesses whether the capital structure theory is portable to small firms in developing countries, and whether family ownership and management play a role in their financing decisions.

How do family firms, especially small family firms in developing countries decide on their capital structure?

This new research seeks to identify what determines capital structure decisions of small family firms in developing countries. Such firms are generally more representative of the corporate sector in those regions of the world, and previous research has largely focused on large, listed companies.

Prior studies have already suggested that family firms generally differ to other types of firm in their approach to financing decisions. Researchers posit that this is due to specific characteristics of the family firm, which place great importance on personal connections with creditors, the firm’s reputation, and quite naturally, its survival.

The paper asks three questions:

  1. Are the capital structure choices of small firms in developing countries affected by the same factors affecting large firms?
  2. Does the family ownership of the firm affect the capital structure decisions of small firms in developing countries?
  3. Does the family management of the firm impact on the capital structure decisions of small firms in developing countries?

The researchers used survey data from the Enterprise Survey-Investment Climate Survey. This covers a broad sample of countries around the world, and provides detailed financial, ownership, and management information, thus enabling an investigation into the impact of family ownership and management on the corporate financing decisions of small firms.

Results indicate that the corporate financing decisions of small firms and small family firms in developing countries do indeed differ from those of large companies.

For example, in contrast to large firms, small family firms do not follow either the pecking order, or the trade-off theories.

The study finds that the size of the firm is an important factor in its level of gearing. Larger firms can borrow more. Due to information asymmetries and high inflation in developing countries, small family firms usually face higher interest rate costs. They are also considered financially riskier than large firms. As a result, debt financing becomes expensive for small family owned companies.

The research also finds that the country of incorporation is an important determinant for the debt financing decisions of small family firms, as they are sensitive to institutional characteristics, and the macroeconomic environment variables of the country.

The study notes that difference in capital structure choices between small and large family firms is related to their different management styles.

Finally, the researchers observe that further economic development of the developing countries might motivate small family firms to extend their maturities of debt, and prefer long-term debt over short-term debt.

On the whole, the results suggest that the capital structure decisions of small family firms in developing countries are not similar to those of large listed firms in developed markets, or to bigger SMEs in developing countries. Capital structure theories are portable to developing countries in the case of large firms but country characteristics are at work for the external financing decisions of small family firms in developing countries. Size is another important factor in capital structure decisions. Ownership and management are more important for the capital structure decisions in the case of large firms.

The paper Capital Structures of Small Family Firms in Developing Countries is available for download from City Research Online.