Do Finnish SMEs follow capital structure theories?

Abstract

This paper aims to understand the capital structure decisions of small and mid-sized companies (SMEs) in Finland. The well-known pecking order theory and trade-off theory are being tested by utilizing 14,319 Finnish SMEs’ financial statement information from 2000 to 2022. The methodology tests whether company-specific characteristics can explain Finnish SMEs’ capital structure decisions.

Furthermore, the paper reviews the latest literature on capital structure theories, SME financing, and the Finnish SME credit environment. Findings from the earlier literature make us conclude that the well-known capital structure theories may not be fully applicable to SMEs. This can be seen also in our examination results.

The results show strong support for the pecking order theory while the support for the trade-off theory is weak. The findings indicate Finnish SMEs’ leverage to be positively associated with the tangibility of assets, non-debt tax shields, and growth opportunities, while their leverage seems to be negatively associated with profitability and size. These findings add further evidence to the somewhat controversial field of findings on capital structure literature of SMEs.

Our paper concludes that to understand SME financing better, the examination should also consider the operational motives of SMEs. The prevailing capital structure theories are built on the assumption that companies operate in a wealth-maximizing manner. However, in the context of SMEs, the company's purpose might also be something else.