Small Firm Use Of Leverage

42 Pages 10494 Words

5, 1996, Petersen & Rajan, 1994; Scherr et al.,
1993). Some prior research has suggested, however, that women-owned businesses experience greater difficulties in
borrowing than businesses owned by men (Brush, 1992; Buttner & Rosen, 1988; Collerett & Aubry, 1990; Riding &
Swift, 1990). This study compares use of financial leverage by men and women-owned small businesses to determine
if women are less likely to use debt as a source of financing.

Capital Structure and the Small Business

Modigliani & Miller (1958) theory of capital structure states that firms will select the mix of debt and equity that
minimizes their weighted average cost of capital. Because interest expense is tax deductible, debt is less costly than
equity as a source of capital. Therefore, firms, in principle, act to minimize the cost of capital and maximize the value of
the firm by financing with debt. Other researchers have suggested alternatives to the Modigiliani and Miller theory of
capital structure. Timmons (1994) observes that capital requirements are different at different stages of firm growth.
Small, young firms may be able to draw capital from internal sources such as earnings and informal sources such as
family and friends. As the successful firm grows, however, more capital is required to finance growth, and the firm
typically needs at some point to turn to external sources such as banks and the public debt and equity markets. Myers
(1984) alludes to a "pecking order" theory of finance stating that firms use internally generated funds in the form of
retained earnings before turning to external sources. When retained earnings are exhausted, firms will first seek out
sources of debt and will use more costly external equity only as a last resort.

A number of studies have compared the capital structures of small businesses to those of larger firms to demonstrate
small business' dependence on debt financing. U...