Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

Small firms need more access to credit during financial troubles

06.10.2010
When the economy sours, small firms seeking credit tend to face higher costs of financing, leading them to reinvest their profits before they pay off creditors, according to research published by a University of Illinois finance expert.

Small firms, especially those considered financially constrained as a result of their size, low dividend payment or lack of bond rating, often become bogged down in debt because they "get hooked on cheap money, when they can find it" says U. of I. finance professor Murillo Campello.

Heitor Almeida"Since small firms are usually financially constrained, they try to grab all the cash they can get their hands on, whether it's internal or external," he said.

As long as the economy is doing well, life is good for small firms. But when there's an economic slowdown or a financial crisis, creditors want their money back, Campello says.

"Big firms are usually unconstrained by outside financing costs, and are able to weather the slowdown by paying back their creditors," Campello said. "Small firms will not necessarily pay off the debt like the big firms would, but will instead re-invest in their business until it becomes highly profitable. This is where small, financially constrained firms get into trouble, because then they owe a lot of money."

The study, co-written by U. of I. finance professor Heitor Almeida and published in the Journal of Financial and Quantitative Analysis, seeks to answer what Campello calls the "holy grail" of corporate finance: how firms finance themselves.

"We discovered that when you look at how firms finance themselves, they're thinking: 'How should I finance this idea? Should we raise equity, issue debt or use general cash?' Since external financing is always expensive, these are huge question for firms. The idea is that firms reach first for internal funds, and then if that's not enough, they look outside for external funds."

Large firms are less likely to face high costs of external financing, while small firms with fewer financial resources will invariably face higher costs.

"When financial markets tighten, the big firms are usually able to pay off their debt," Campello said. "In corporate finance, this paradigm is called the pecking-order theory. Big firms tend not to accumulate too much cash; they pay back what they owe to creditors before the money gets too expensive."

But as small firms invest, if they have profitable returns on their investments, they tend keep the cash in-house and buy more tangible assets.

"If they are allowed, small firms usually don't pay back their creditors, they just keep on investing," Campello said. "Those assets can then be used as collateral, and with that collateral there is more credit, hence more funds to invest. So many times they don't necessarily pay back their creditors, they just invest more. But in the process, they may become more leveraged, and owe more money to outsiders."

For policy-makers, Campello says it's imperative to create new instruments for how small firms handle external funds during a financial crisis, including mechanisms to lower interest rates or help banks extend additional lines of credit.

"It's important for policy-making in that, during a financial crisis, you need to think about avoiding unemployment, factories closing down and jobs moving abroad," he said. "But we also need policies that target those firms that are addicted to external financing as well as laws to help creditors feel like they can lend more at lower costs."

But putting in too much regulation makes lending expensive.

"Later on, what happens is that crises become more acute, and, potentially, even productive firms would be punished the most by the high costs of external financing," Campello said.

Phil Ciciora | EurekAlert!
Further information:
http://www.illinois.edu

More articles from Studies and Analyses:

nachricht Europe’s Demographic Future. Where the Regions Are Heading after a Decade of Crises
10.08.2017 | Berlin-Institut für Bevölkerung und Entwicklung

nachricht Scientists reveal source of human heartbeat in 3-D
07.08.2017 | University of Manchester

All articles from Studies and Analyses >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: Fizzy soda water could be key to clean manufacture of flat wonder material: Graphene

Whether you call it effervescent, fizzy, or sparkling, carbonated water is making a comeback as a beverage. Aside from quenching thirst, researchers at the University of Illinois at Urbana-Champaign have discovered a new use for these "bubbly" concoctions that will have major impact on the manufacturer of the world's thinnest, flattest, and one most useful materials -- graphene.

As graphene's popularity grows as an advanced "wonder" material, the speed and quality at which it can be manufactured will be paramount. With that in mind,...

Im Focus: Exotic quantum states made from light: Physicists create optical “wells” for a super-photon

Physicists at the University of Bonn have managed to create optical hollows and more complex patterns into which the light of a Bose-Einstein condensate flows. The creation of such highly low-loss structures for light is a prerequisite for complex light circuits, such as for quantum information processing for a new generation of computers. The researchers are now presenting their results in the journal Nature Photonics.

Light particles (photons) occur as tiny, indivisible portions. Many thousands of these light portions can be merged to form a single super-photon if they are...

Im Focus: Circular RNA linked to brain function

For the first time, scientists have shown that circular RNA is linked to brain function. When a RNA molecule called Cdr1as was deleted from the genome of mice, the animals had problems filtering out unnecessary information – like patients suffering from neuropsychiatric disorders.

While hundreds of circular RNAs (circRNAs) are abundant in mammalian brains, one big question has remained unanswered: What are they actually good for? In the...

Im Focus: RAVAN CubeSat measures Earth's outgoing energy

An experimental small satellite has successfully collected and delivered data on a key measurement for predicting changes in Earth's climate.

The Radiometer Assessment using Vertically Aligned Nanotubes (RAVAN) CubeSat was launched into low-Earth orbit on Nov. 11, 2016, in order to test new...

Im Focus: Scientists shine new light on the “other high temperature superconductor”

A study led by scientists of the Max Planck Institute for the Structure and Dynamics of Matter (MPSD) at the Center for Free-Electron Laser Science in Hamburg presents evidence of the coexistence of superconductivity and “charge-density-waves” in compounds of the poorly-studied family of bismuthates. This observation opens up new perspectives for a deeper understanding of the phenomenon of high-temperature superconductivity, a topic which is at the core of condensed matter research since more than 30 years. The paper by Nicoletti et al has been published in the PNAS.

Since the beginning of the 20th century, superconductivity had been observed in some metals at temperatures only a few degrees above the absolute zero (minus...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

Event News

Call for Papers – ICNFT 2018, 5th International Conference on New Forming Technology

16.08.2017 | Event News

Sustainability is the business model of tomorrow

04.08.2017 | Event News

Clash of Realities 2017: Registration now open. International Conference at TH Köln

26.07.2017 | Event News

 
Latest News

A Map of the Cell’s Power Station

18.08.2017 | Life Sciences

Engineering team images tiny quasicrystals as they form

18.08.2017 | Physics and Astronomy

Researchers printed graphene-like materials with inkjet

18.08.2017 | Materials Sciences

VideoLinks
B2B-VideoLinks
More VideoLinks >>>