CAPITAL STRUCTURE OF SMEs IN UK

Capital Structure of SMEs in UK

Abstract

This paper offers an empirical look at the corporate performance and capital structure of SMEs from UK. The paper combines two strands of business research: one from the international business field on corporate performance and country of origin; and the other from corporate finance research on capital structure. We study corporations from UK and find that both financial performance and capital structure are influenced by the country of origin. Specifically, we find that corporations have significantly higher returns on equity and invested capital than corporations from the other countries, possibly reflecting the concentrated conglomerate business structure typical of UK. The performance differences among firms from other countries are not statistically significant. Firms have significantly higher leverage than firms from the other countries. Leverage itself does not seem to affect corporate performance.

Table of Contents

Chapter 1: Introduction5

Aims and Objective6

Significance7

Shortcomings9

Capital Structure Theory10

What is capital structure?11

Chapter plans11

Chapter 2: Review of Related Literature13

Measures of Capital Structure15

Theories On Capital Structure17

Shortcomings Of The Modigliani & Miller Theorem21

The Static Trade-Off Theory25

Empirical Evidence26

The Free Cash Flow Theory27

Informal Asymmetry Hypothesis28

The Signaling Theory28

The Pecking Order Theory30

The pecking order theory vs. The trade-off theory32

Reported practice33

Financial intermediaries (size_fin.intermed)34

The efficiency of the legal system (legal_efficiency)35

Commercial law: creditor and shareholder rights (creditor_rgt, shareholder_rgt)36

Firm-specific Capital Structure Determinants37

Chapter 3: Methodology40

Sample Selection40

The Econometric Model44

Chapter 4: Results and Discussion47

Data Analysis47

Descriptive Statistics of Country-Specific Variable49

Determinants of Debt Levels Across Countries52

Means of OLS Regression55

Presenting Data about Capital Structure Adjustments Across Countires58

Effects of Institution- and Market-specific Characteristics on Debt Adjustments60

Capital Structure Adjustments62

Robustness Tests63

The Pecking Order Or Static Trade-Off Theory64

The Capital Structure Decision : International Evidence65

Bankruptcy law66

Chapter 5: Conclusion69

Reference73

Chapter 1: Introduction

Many international business researchers have argued that increased globalization of markets and increasing international competition imply that firms in all nations will face similar, if not identical, competitive environments. If companies respond in similar ways to the global marketplace and the pressures of competition, profitability performance would not be a consistent function of the country of origin. Several studies have compared the performance of corporations across countries and tested for differences in performance that can be traced to the country of origin. The evidence presented by these studies has been mixed. While most of the earlier studies found some significant differences in performance linked to the home country, Blaine (1994) found that during the latter half of the eighties, large German, Japanese and American corporations earned roughly equivalent rates of return. Nearly all of the previous studies on corporate performance across countries use data from the industrialized countries of Europe, US, and Japan. Further, most of these studies use only accounting performance measures and do not attempt cross-sectional analysis to link corporate financial policies to performance.

There is a large body of theoretical and empirical research on the determinants of capital structure. Most of the empirical research has focused on US corporate data. The few studies that analyze the capital structure of corporations from other countries tend to look at companies in the major industrialized ...