Capital Structure Of Smes

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Capital Structure of the Small and Medium Enterprises (SMES) in UK: Evidence


This study purely focuses the determinants of the capital structure of the small and medium enterprises(SMES) in UK. Its different parts covers evidence from regional comparison between Southern and South Western in UK (2001-2005). In this study I will discuss determinants of the capital structure with clear arguments and logical evidence. In the end, this research will give us the better view of the subject.

Table of Contents


Literature Review and Hypotheses9

Firm Growth10

The Trade-Off And Pecking Order Theories11

Empirical Determinants Of Capital Structure24


Asset Structure26




Non-Debt Tax Shield29


Industry Effect30

The Static Trade-Off Theory30

The Free Cash Flow Theory33

Informal Asymmetry Hypothesis34

The Signaling Theory34

The Pecking Order Theory36


Business Risk40

Firm Size41

Firm Ownership42

Relationships with Banks43


Methodology and Measurement of Variables45

Data Collection45

Measuring Variables47

Methods of Analysis50

Results and Discussion51

Descriptive Statistics51

Empirical Analysis and Result Discussion57





Capital Structure


Capital structure is defined as the relative amount of debt and equity used to finance a firm. Theories explaining capital structure and the variation of debt ratios across firms range from the irrelevance of capital structure, proposed by Modigliani and Miller (1958), to a host of relevance theories. If leverage can increase a firm's value in the MM tax model (Modigliani and Miller 1963; Miller 1977), firms have to trade off between the costs of financial distress, agency costs (Jensen and Meckling 1976) and tax benefits, so as to have an optimal capital structure. Capital structure refers to the composition of a firm's liabilities and owners' equity. Capital structure decisions are related to the magnitudes of liabilities and owners' equity. Capital structure decisions are one of the three financing decisions - investment, financing, and dividend decisions - finance managers have to make (Van Horne and Wachowicz, 1995).

Capital structure of a firm determines the weighted average cost of capital (WACC). WACC is the minimum rate of return required on a firm's investments and used as the discount rate in determining the value of a firm. A firm can create value for its shareholders as long as earnings exceed the costs of investments (Damodaran, 2000). A number of theoretical and empirical studies investigated the optimal capital structure of a firm. These studies pointed out the importance of the relationships among capital structure, cost of capital, capital budgeting decisions, and firm value.

Although capital structure theory is a widely studies topic, there are fewer studies on the capital structure of firms in the tourism industry. Kwansa and Cho (1995) investigated the impact of the trade-off between financial distress costs and tax earnings in the US restaurant industry. They reported a significant bankruptcy cost effect on capital structure and firm value. Upneja and Dalbor (1999) detected a positive relationship between before and after tax rates of US restaurant companies and their leasing activities. Özer and Yamak (2000) examined financial sources used by lodging companies with less than 100 rooms located in Istanbul. They found that lodging companies appear to use internal funds and debt, respectively, in their investment stage, while retained earnings are the major source of funds in the operating ...
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