The capital structure and investment decisions of the small owner-managed firm: Some exploratory issues

In the burgeoning literature on small firm financing, the problem of underidentification in respect to the supply of, and demand for, capital has not been fully resolved. In an attempt to progress this issue, the current paper looks at some of the issues influencing the demand for finance in small firms which are owner-managed. The paper is primarily exploratory in nature and argues that a greater emphasis might usefully be placed on the cost of capital dimension in future research into small business financing. In particular, it is suggested that where the objective of an owner-manager is to maintain control of the firm, interdependent investment and financing strategies may be chosen to control the small firms cost of capital. This in turn indicates that the tendency for some small firms to invest sub-optimally and exhibit slower than average growth may not be primarily determined by limitations on their supplies of finance. On the demand side, it may well be that in addition to equity aversion, a suboptimal capital structure decision is made in the form of a reduced demand for debt. In other words, given the level of equity that an owner-manager chooses, debt may not be fully expanded to the capacity limit consistent with value maximisation.