Implications and Conclusions

This chapter sheds light on small business capital structure theories. The novelty contribution of this chapter is that, relationship lending and banking market concentration work pronouncedly as the determinants of small business capital structure decisions together with the reverse financial life cycle theory. Although ample empirical research has been carried out on the determinants of small business capital structure, this chapter is unique in checking the favourable/unfavourable effects of relationship lending and banking market concentration from a capital structure perspective, measured as both total debt ratio and long- term debt ratio.

Since asymmetric information plays a fundamental role in both capital structure theory (Lambert et al., 2012) and relationship lending theory (Petersen and Rajan, 1994), there should, theoretically, be close links between capital structure and relationship lending, and such impacts could only be found in a non-competitive banking market, which is consistent with the theoretical models proposed by Petersen and Rajan (1995). This chapter is unique in applying both traditional capital structure theories and relationship lending theories together to outline the relationship between firms’ capital structure and relationship lending. The major findings are, firstly, there is a general application of the reverse financial life cycle

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Further robustness checks have been carried out. For example, the comparisons between corporations and non-corporations have been done. The reverse financial life cycle theory and relationship banking theory well perform among the corporations.

154 effect on financial leverages for all of the small businesses, and such an effect does not vary across different banking market conditions. Firms’ reduce the leverage as their financial life increases. Secondly, relationship banking has been found to be beneficial to small firms in reducing financial risks and, therefore, allows more tax-shield benefits. It enables the firms to reduce the speed of reduction of their leverage. Thirdly, without considering relationship banking, banking market concentration itself might have a weak detrimental effect on small businesses supporting the existence of SCP or RMP. Fourthly, the beneficial effect of relationship banking applies better for corporations than non-corporations. Overall, theoretically speaking, this chapter reveals that SCP/RMP and Information Hypothesis are not mutually exclusive. And in a concentrated banking market, as the banking relationship develops, the speed at which the financial leverage drops is significantly lower than that in a competitive banking market.

This chapter informs both banks and small businesses. For the banks, especially in the concentrated banking market, relationship lending is an effective lending technology where there might be greater demands from small business customers. When designing relationship lending products, the banks need to also understand there is a decreasing demand for credit as the banking relationship lengthens and that in a competitive banking market this demand drops more quickly than in a moderately or highly concentrated banking market. For small businesses, relationship lending is still a very important tool for obtaining external finance in a concentrated banking market to better use financial leverage.

The research is subject to some limitations. Firstly, although SSBF offers the information about banking market concentration measured at microeconomic scale which is much advantageous than country or state level, the proxy provided by SSBF is categorical rather than continuous variables. It is not available to test the non-linear effect of banking market concentration which might be potentially an issue as considered by Chong et al (2013).

155 Moreover, since the postal codes of the firms are confidential, it is not feasible to establish some alternative proxies of banking market concentration, e.g. Concentration Ratios, Lerner’s Index, etc., which may help show a more comprehensive view of banking market concentration. Therefore, in the future if SSBF could publish the postal code, it would be beneficial for further research in depth.

Secondly, due to the cross-sectional nature of SSBF, it is not available for the research to follow the dynamic adjustment models to empirically test the convergence of capital structure towards to the optimal level (Ozkan, 2001). The causality could not be examined econometrically as well. Moreover, since the companies in the pools in each round of survey are not the same, it is not yet available to track the lagged or long-term effect of banking market concentration on firms’ capital structure decisions. Thus, we call for more the future in the panel data structure.

As raised by Petersen and Rajan (1994), the external finance for small firms could be affected by both of the supply and demand sides of the credits. SSBF provides comprehensive information regarding the demand sides of the credits, however, due to the confidentiality of the firms’ addresses and the survey, more information regarding the supply side of the credits is not available. Therefore, the research has limited power to capture the impacts on firms’ capital structure from the banks. In the future survey, if this issue could be considered and the data regarding this issue could be published, it would facilitate the research in depth.

Although the latest SSBF dataset was released in October 2008, the last round of the survey happened in 2003 or 2004, which was more than 10 years ago. There is still numerous research focusing on SSBF dataset, e.g. Cole and Mehran (2016), Cassar et al (2015), Han et al (2015), etc. However, concern rises as that the external finance for small business with a more updated effectiveness, particularly during and after the financial crisis, might be more

156 valuable to be focused on (Berger et al, 2015). It is not available to empirically test such an issue by SSBF. Therefore, new round of survey is called for.

Apart from the above limitations, the research could also be improved in future in the following approaches: firstly, the research could be conducted separately in 1998 and 2003, and in this way, it enables to investigate the impacts of Interstate Banking and Branching Efficiency Act (IBBEA) in effect since 1997. Moreover, according to Petersen and Rajan (1994 and 1995), the asymmetric information problem is less severe for older firms than younger firms, as well as larger firms than smaller firms. Thus, it is also considerable to split the SSBF dataset by younger firms group and older firm group, or medium-sized group and small-sized group for analysis and comparison.

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Chapter Three: Why Small Business Borrow from Non-