Do Small and Medium Sized Enterprises Match Their Assets and Liabilities? Evidence from Portugal

By Bartholdy, Jan; Mateus, Cesario et al. | The International Journal of Business and Finance Research, October 1, 2012 | Go to article overview

Do Small and Medium Sized Enterprises Match Their Assets and Liabilities? Evidence from Portugal


Bartholdy, Jan, Mateus, Cesario, Olson, Dennis, The International Journal of Business and Finance Research


ABSTRACT

For small and medium-sized enterprises, various types of debt are not identical. There are specific costs and benefits associated with each funding source. We argue that the asset and liability sides of the balance sheet are interrelated. Specifically, we hypothesize that firms match specific assets with a specific set of liabilities. We test our theory using a unique sample of Portuguese firms for the years 1990-2000. Our data set identifies various short-term and long-term funding sources, as well as the uses of these funds to purchase various assets. Our results reject independence between the two sides of the balance sheet-suggesting that small and medium-sized firms in Portugal do indeed match specific assets with specific liabilities. The implication for financial theory is that each asset or project may have a different weighted average cost of capital. That is, there is no single weighted average cost of capital for a typical small to medium-sized firm.

JEL: G32, M40

KEYWORDS: Asset-liability matching, SMEs, capital structure, sources and uses of funds

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Most of the literature on capital structure has implicitly assumed that the choice between debt and equity depends solely on firm characteristics, or the firm's demand for debt. For example, Rajan and Zingales (1995) and Booth et al (2001) focus on the demand side of capital structure for large listed firms. However, Faulkender and Petersen (2005, p. 46) have shown that a firm's debtequity structure depends "not only on the determinants of its preferred leverage (the demand side) but also the variables that measure the constraints on a firm's ability to increase its leverage (the supply side)." Also, as noted by Stowe, Watson, and Robertson (1980, p. 973), "the actual balance sheets of modern corporations do not exhibit an independence between the two sides of the balance sheet."

Although the finance literature has recognized the interrelationship between the two sides of the balance sheet, the implications have received little attention. It means the cost of capital can vary between assets, so that a firm need not have a single weighted average cost of capital (WACC). While asset and liability interdependence may not be so important for large corporations, capital constraints and differential costs between the sources of debt capital can have a major impact on small and medium enterprises (SMEs). For SMEs, the cost of funds may vary on a project-by-project basis depending on project size, riskiness, and time horizon. Each source of debt conveys its own particular set of costs and benefits and a firm may choose a different mix of funding sources for each asset it purchases. In this paper, we propose that the two sides of the balance sheet of SMEs are interdependent causing them to match specific assets with specific liabilities. The firm's optimal capital structure then depends on the assets they purchase.

We empirically test our theory of asset and liability matching using a unique sample of 1416 Portuguese industrial SMEs over the years 1990-2000. This data set provides detailed information about sources of SME funding - including internal equity, bank loans, trade credits, non-bank loans, leasing, and other short-term debt. For these SMEs, we test for independence between sources of funding and the uses of funds to purchase various assets. Our tests reject independence, suggesting the asset and liability sides of the balance sheets are interrelated. Each asset class has its own unique mix of financing sources. Our results suggest that all types of debt are important for SMEs and that empirical work in finance should distinguish between various types of debt. Thus, a firm does not have a unique average weighted cost of capital and decisions about capital structure become more complicated than in traditional analysis. The debt portion of the debt-equity ratio depends upon the type of debt a firm uses. …

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