The determinant of capital structure in SME’s: evidence from UK and China.

Abstract

The concept of capital structure and its related determinants has received significant attention in academic discussion due to a change in the financial environment allied to changes to the economic climate over the last several decades. To mitigate these changes and challenges, an understanding of capital structure variances from certain aspects of firm, industry and country-specific levels has been the focus of research in this area. This has resulted in an emphasis on the financial implications of such capital structure variance building an understanding of the influences of its determinants when economic environments change. However, results of the research to date is inconsistent due probably to the heterogeneity of sampled firm in a changing financial market. Therefore, these inconsistent results leave a gap in the literature that needs for further investigation. The main research aim of the study is to investigate and analyse the determinant of capital structure in listed small and medium sized firms in the UK and China. There are three specific objectives strategically generated to contribute to the existing literature on the subject matter. Firstly, to investigate the impact at firm, industry and country-specific levels on capital structure variance of firms using both market and book based values in specific sector between 2007 and 2017. Secondly, to analyse the relationship between capital structure and its determinants by using panel data fixed effect to analyse their direct and indirect influence. Thirdly, to examine using the same model, the dummy effects of time, industry and financial systems on capital structure. To achieve these research objectives, the study uses two samples, namely, 510 firms on the UK Alternative Investment Market (AIM) All Share Index and 759 listed firm on the China SMEs Board Market from the period 2007 and 2017. The secondary data used in the study is acquired from DataStream, The World Bank and National Statistical Bureaux of the UK and China. The analysis initially uses the Haussmann test in Stata to determine, within the context of a panel data analysis, whether fixed or random effects should be utilised. The evidence predicated the use of fixed effects. The need for a heightened awareness of environmental management has been highlighted as a results of climate change, global warming and other related environmental challenges that have occurred over the last three decades. To mitigate these challenges, efficient environmental processes, strategies, policies, initiat ives and practices have been adopted by a number of companies and countries. As a result, research scholars have highlighted the financial implication of engaging in such environmental management activities and research has focussed on advanced investigations to understanding the relationship between corporate environmental performance (CEP) and corporate financial performance (CFP). However, results to date are inconsistent and contradictory thus, leaving a gap in the literature that calls for further examination. An analysis of descriptive statistics indicate that the Basic Material, Industrial, Health and Consumer Services sectors are the most prominent representatives in the AIM sample. The Basic Material, Industrial and Consumer Goods sectors are the mo st significant sector in the sample of SMEs Board Market. Several studies indicate that firms in the Financial and the Utilities Sectors should not be included in the sample because their financing decisions are supervised and regulated by government. The capital structure of firms in these sectors have a different composition compared to firms in the non-regulated sectors. In order to provide accurate empirical evidence, this research investigates the determinants of capital structure excluding the Financial and Utilities sectors. On AIM, it is found that the capital structures of the Oil and Gas , Technology and Consumer Goods sectors are mainly explained by firm-specific determinates. The capital structures of the Industrial sector relies on factors with industry characteristics, but the capital structure of the Health Care, Consumer Services, Consumer Goods, Industrial and Basic Materials sectors are more influenced by macroeconomic change. In the SMEs board, the capital structures of the Health Care, Technology, Oil and Gas and Consumer Services sectors are mainly explained by determinants related to firm characteristic. The financing decisions of the Consumer Goods, Industrial and Basic Materials sectors are influenced more by factors arising from the economic environment. Furthermore, industry characteristic variables have a stronger explanatory powers in the Industrial, Consumer Services, Industrial and Health Care sectors. The regression estimators also indicate that the overall difference in capital structure variance between the AIM and SMEs board is not significant. Financing structure of firms in AIM are explained more by factors with firm characteristic than those in SMEs board with no effect being observed from industry characteristics? However, industry characteristics does also play an important role in firm’s capital structure in SMEs Board. The short term leverage element of the capital structure of firms on AIM is mainly explained by factors firm characteristic with these factors having a lower explanatory power in the SMEs board. On the SMEs board, the factors with industry and country characteristics have the greatest influence on short term leverage of firms. Regarding long term leverage, there is not significant difference between AIM and the SMEs board with industry-specific factors affecting the long term rather than the short term leverage of firms in AIM. Furthermore, using panel data with fixed effects, it is found that the capital structure of firms in both the markets is significantly affected by the time, industrial and financial system dummy. The effect of the industrial variable plays a significant role in the financing decisions of firms on AIM. With no difference being observed between short term and long term leverage. However, in the SMEs board, the industrial variable only affects short term leverage with no empirical evidence showing any significant effect on long term leverage. However, the time variable on capital structure shows different results between AIM and the SMEs board. Overall, the effect of the time variable on AIM is twice that of its influence on the SME’s board and in relation to short term leverage on AIM its effect is four times as significant. In relation to the influence of the financial system variable there is no difference in the absolute value of its impact between AIM and the SME’s board. The study contributes to knowledge and the existing literatures in several ways. The primary contribution is the analysis of the hierarchical and dimensional construct of capital structure variance. The study analyses the different aspects of financing choice made by firms given the influence of time, firm characteristics, industry and country. Also, the proxies of capital structure are grouped as short-term and long term leverage with both measured in relation to market and book value. For example, there is evidence that firm size is positively related to short term leverage in the market value of firms on AIM whereas it has a significantly adverse impact on book value. Also, the distance from bankruptcy (default risk) is found to be negatively related to short term leverage of firms in the SME board, while it positively affects long term leverage. These contradictory results suggest that there is a motivation to measure the relationship between capital structure and its determinants to provide more explanatory power. Furthermore, the results provide statistical evidence to support existing literature on the non-linear relationship between capital structure and its determinants in relation to firm characteristics. The study’s distinction of the non- linear relationship between capital and non-capital intensive firms assists managers in utilisation of the marginal effects of conditional variables on financing choice. Finally, the study contributes to the capital structure literature by identifying the capital structure choice of small and medium sized firms in the developed country of the UK and emerging country of China from 2007 to 2017 providing evidence of the distinction between UK and Chinese firms, which contributes to the understanding of financing preferences in different financial markets.