Family fortunes: new research unpicks capital structures of small family firms in developing countries

New research from Bayes Business School (formerly Cass) has found that family-owned companies from developing markets decide on their capital structures depending on their size, management style and country of incorporation.

‘Capital Structures of Small Family Firms in Developing Countries’, co-authored by Kate Phylaktis, Professor of International Finance & Director of The Emerging Markets Group at Bayes, along with academics from Istanbul Gelisim University and Queen Mary University London, examines how levels of leverage vary between small family firms, large family firms and non-family firms across different countries and market cultures.

Survival of family firms often hinge on the creation of longstanding relationships with creditors that are then passed down to future custodians. On the one hand, this can allow family firms to hold higher debt levels than other types of firm, but on the other it may deter them through fear of using control and damaging healthy relationships with creditors. The research aimed to uncover circumstances which dictate respective financing decisions.

The study used survey data from 10,839 firms of all sizes and ownership structures across 24 developing countries from between 1999 and 2002. The sample set yielded a total of 13,343 independent observations for small firms over a two or three-year period.

Key findings from the research include:

• The size of a firm is important in determining the amount of leverage it holds. As firms become larger, they increase leverage in capital structures. Larger, more diversified firms – including large family firms – are more readily able to increase their leverage due to lower information asymmetries, reduced risk of failure and more favourable interest rate costs.
• Country-level characteristics and macroeconomic variables impact small firms and small family firms significantly more than they impact larger family and non-family firms in terms of capital structure choices. External financing is more difficult to obtain for smaller firms incorporated in unstable macroeconomic environments.
• Economic conditions of the country of incorporation have significant impact on leveraging, with higher GDP per capita linked to a preference for long-term debt financing. Therefore, small family firms in developing countries tend to maximise short-term debt and borrowing linked to holding lower levels of debt.
• The characteristics of ownership and management affect capital structure decisions of large firms in developing countries, but not small family firms because owners are generally the managers, which lessens the likelihood and impact of conflict, as described by agency theory. Owner-managers in small and family firms are therefore less likely to use debt financing than owners of larger firms because they do need to contend with management’s overinvestment tendencies that maximise their own wealth over benefiting firm value.
• Small family firms in developing countries are less reliant on debt financing and are generally funded by short-term debt that does not require collateral. Asset tangibility is therefore negatively related to leverage for these companies, and can be explained by a lack of accessibility to bank-based financing.
• Profitability is not a significant factor in the financing decisions of small family firms in developing countries. They do not follow pecking order theory in the same way that larger organisations or other small firms in more developed countries do.

Professor Phylaktis said the study demonstrated the unique behaviour of small family firms from developing countries towards structuring their finances.

“Capital structures and financing are important to companies of all sizes everywhere in the world, not least when available options may be limited,” she said.

“Family-owned companies face their own set of challenges when it comes to finding capital, yet family ownership is significant among small firms in developing countries.

“Established theory has examined the differences and respective challenges faced by both large and small firms in how they structure their financing. Our research examines patterns and structures of small family firms to see how closely they follow the same rules as firms from developed countries and larger, non-family owned businesses domestically.

“Our research could inform regional lenders of the financing needs and lending appetite of different sizes and structures of firms in the developing world, and help increase access to borrowing for those who need it the most – thus helping to grow national economies and GDP.”

‘Capital Structures of Small Family Firms in Developing Countries’, by Professor Kate Phylaktis, by Tugba Bas, Istanbul Gelisim University, Gulnur Muradoglu, Queen Mary University London and Professor Phylaktis is published in Review of Corporate Finance.