Financing decision, cost of debt and profitability: evidence from non-financial SMEs in the UK

Abstract

The aim of this thesis is to contribute to the existing empirical financial literature on the determinants of capital structure and adjustment process, cost of debt determinants and the affect of capital structure on profitability in the context of non-financial Small and Medium size Enterprises (SME) in the UK. In order to formulate the testable hypothesis different capital structure theories are reviewed.

A firm can choose equity, debt or both to finance its operations. The selection of optimal debt equity mix is a crucial issue in finance. The Generalized Method of Moment (GMM) is considered to control for simultaneous equation bias employing both firm specific and macroeconomic variables. For entire population of non-financial SMEs in the UK using Two Stage Least Square (TSLS) methodology, we focused on determinants of the cost of debt capital and the impact of capital structure on profitability.

Results indicate that findings are consistent with the pecking order theory, trade-off theory and agency theory. Our results show that short term debt plays an important role in capital structure, cost of debt and profitability of SMEs in the UK. Moreover, the short term debt is appeared to be more expensive for the manufacturing sector and more profitable for service sector whilst size and macroeconomic variables have a significant impact on leverage.