TRADE-OFF THEORY VERSUS PECKING ORDER THEORY: CAPITAL STRUCTURE DECISIONS IN A PERIPHERAL REGION OF PORTUGAL

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1 TRADE-OFF THEORY VERSUS PECKING ORDER THEORY: CAPITAL STRUCTURE DECISIONS IN A PERIPHERAL REGION OF PORTUGAL Zélia Serrasqueiro 1, Ana Caeano 2 1 Deparmen of Managemen and Economics, Faculy of Social and Human Sciences, Universiy of Beira Inerior, Covilhã, , Porugal CEFAGE Research Cener Universiy of Évora, Évora , Porugal 2 Deparmen of Managemen and Economics, Faculy of Social and Human Sciences, Universiy of Beira Inerior, Covilhã, , Porugal s: 1 zelia@ubi.p (corresponding auhor); anacaeano19@gmail.com Received 19 December 2011; acceped 16 Ocober 2012 Absrac. Based on a sample of Small and Medium-Sized Enerprises (SMEs) locaed in he inerior region of Porugal for he period , using he LSDVC dynamic esimaor as mehod of esimaion, his sudy ess wheher he capial srucure decisions of SMEs are closer o he assumpions of Trade-Off Theory or o hose of Pecking Order Theory. The empirical evidence obained allows us o conclude ha Trade-Off and Pecking Order Theories are no muually exclusive in explaining he capial srucure decisions of SMEs. The mos profiable and oldes SMEs resor less o deb, which corroboraes he forecass of Pecking Order Theory. SMEs, wih greaer size, resor more o deb, corroboraing he forecass of Trade-Off Theory and Pecking Order Theory. In addiion, SMEs adjus noiceably heir curren level of deb owards he opimal deb raio, which corroboraes wha is forecas by Trade-Off Theory. The resuls sugges ha younger and smaller SMEs of Beira Inerior Region should be objec of public financing suppor, when he inernal financing is clearly insufficien o fund hose firms aciviies. Keywords: Beira Inerior, capial srucure, Pecking Order Theory, SMEs, Trade-Off Theory. Reference o his paper should be made as follows: Serrasqueiro, Z.; Caeano, A Trade-Off Theory versus Pecking Order Theory: capial srucure decisions in a peripheral region of Porugal, Journal of Business Economics and Managemen ifirs: XX XX. Jel Classificaions: C23, G32, L26, M10, M20. Inroducion Trade-Off and Pecking Order Theories have ofen been placed in opposiion, seeking o idenify which of hem offers he bes explanaion regarding capial srucure decisions. The difficuly in accessing o deb, as a consequence of asymmeric informaion problems is considerably relevan in SMEs. According o Scherr and Hulbur (2001), rying o undersand he dynamism of capial srucure in SMEs, is fundamenal, given ha hese companies mus carry ou frequen adjusmens oward he arge deb level, as a consequence of he need o renegoiae he level and erms of deb. Therefore, he objecives of his sudy are o: i) analyse if Trade-Off and Pecking Order Theories, seeking o which of hem offers he bes explanaion regarding SME capial srucure decisions; and ii) analyse if SMEs carry ou adjusmens oward heir arge level of deb. Wih his sudy, we seek o conribue o exending he sudy of SME capial srucure, considering SMEs in he inerior region of Porugal. Regional dispariies in erms of economic growh and economic developmen are a real problem in economy. In his conex, Álvarez-Herranz e al. (2011), Bisrova e al. (2011) and Valackienė and Virbickaiė (2011), conclude ha he firms aciviy may be a paricular imporance o economic growh and economic developmen o regions. I is imporan o analyse he financing decisions of SMEs locaed in an inerior and a less developed region of Porugal, looking for resuls ha may be exended o he conex of counries or regions wih paricular raes of developmen. To reach he main objecives of his sudy, we consider a sample of 53 1

2 SMEs for he period beween 1998 and As mehod of esimaion, we use panel daa models, namely he LSDVC (2005) dynamic esimaor. In general, he resuls sugges ha Pecking Order and Trade-Off Theories are no muually exclusive in explaining he capial srucure decisions of SMEs Afer his inroducion, his sudy is srucured as follows: Secion one gives a review of he lieraure on Trade-Off and Pecking Order Theories; Secion wo presens he mehodology; Secion hree presens and discusses he resuls obained; and finally, he las Secion presens he conclusions, limiaions and suggesions for fuure research. 1. SME Capial Srucure Decisions and Research Hypoheses 1.1. Trade-off heory research hypoheses Trade-Off Theory claims ha firms have an incenive o urn o deb as he generaion of annual profis allows benefiing from he deb ax shields. According o several sudies (DeAngelo, Masulis 1980; Fama, French 2002; López-Gracia, Sogorb-Mira 2008), a posiive relaionship is expeced beween he effecive ax rae and deb. On he basis of his argumen, he firs hypohesis is formulaed in he conex of Trade- Off Theory: Hypohesis 1: There is a posiive relaionship beween he effecive ax rae and deb in SMEs. According o DeAngelo and Masulis (1980), non-deb ax shields, such as deducions allowed by depreciaions and invesmen ax credi could subsiue he role of ax savings permied by deb. This implies ha a firm wih a high level of non-deb ax shields will probably have a lower level of deb han a firm wih low non-deb ax shields. The Trade-Off Theory forecass a negaive relaionship beween non-deb ax shields and deb, herefore i is formulaed he following research hypohesis: Hypohesis 2: There is a negaive relaionship beween oher non-deb ax shields and deb in SMEs. The mos profiable firms have capaciy for a higher level of deb, aking advanage of deb ax shields (Fama, French 2002). Highly profiable firms are likely more able o fulfil heir responsibiliies regarding he repaymen of deb and ineress, which conribues o a less likelihood of bankrupcy. The anerior argumens jusify he possibiliy of a posiive relaionship beween profiabiliy and deb, and so he following hypohesis is formulaed: Hypohesis 3: There is a posiive relaionship beween profiabiliy and deb in SMEs. Myers (1984) saes ha as bankrupcy and agency coss are greaer for firms wih high expecaions of growh opporuniies, firms can be relucan o use high amouns of deb so as no o increase heir likelihood of bankrupcy. As a resul, firms wih high growh opporuniies may no use deb as he firs financing opion. According o he Trade-Off Theory, firms wih greaer growh opporuniies have a lower level of deb, given ha greaer invesmen opporuniies increase he possibiliy of agency problems beween managers/owners and crediors, because he former have a grea incenive o underinves (Myers 1977). Based on hese argumens, he following research hypohesis is formulaed: Hypohesis 4: There is a negaive relaionship beween growh opporuniies and deb in SMEs. Tangible asses can be used as collaerals in he case of firm bankrupcy, proecing he crediors ineress. Michaelas e al. (1999) claim ha firms, wih valuable angible asses, which can be used as collaerals, have easier access o exernal finance, and hey have probably higher levels of deb han firms wih low levels of angible asses. Therefore, in he Trade-Off approach, a posiive relaionship is forecas beween asse angibiliy and firms level of deb, and so he following hypohesis is formulaed: Hypohesis 5: There is a posiive relaionship beween angibiliy of asses and deb in SMEs. Larger firms end o have greaer diversificaion of aciviies ha implies less likelihood of bankrupcy (Timan, Wessels 1988). In addiion, large firms wih less volaile profis are more likely o ake advanage of he deb ax shields, so increasing he poenial benefis of deb (Smih, Sulz 1985). Therefore, according o he Trade-Off approach, large firms end o increase heir level of deb as a consequence of he lesser likelihood of bankrupcy, and also as a way o increase he deb ax shields. Therefore a posiive relaionship is expeced beween size and deb, as defined in he following hypohesis: Hypohesis 6: There is a posiive relaionship beween size and deb in SMEs. We can argue ha age can be an imporan deerminan of capial srucure decisions, given ha he firms in he laer sages of heir life-cycle have more advanageous erms in obaining deb han young 2

3 firms. According o Ramalho and Silva (2009), he older is he firm (and he greaer is is repuaion), he lower is he cos of deb, as long as crediors believe ha he firm will no underake projecs ha imply he subsiuion of asses. Therefore, a posiive relaionship is expeced beween age and deb, as formulaed in he following research hypohesis: Hypohesis 7: There is a posiive relaionship beween age and deb in SMEs. SMEs are subjec o higher business risk, and greaer probabiliy of bankrupcy. Consequenly, SMEs end o reduce heir level of deb. Therefore, according o Trade-Off Theory a negaive relaionship is expeced beween firms level of risk and deb, as formulaed in he following research hypohesis: Hypohesis 8: There is a negaive relaionship beween risk and deb in SMEs. According o Trade-Off Theory, here is an opimal deb raio, which is he raio where ax benefis are equal o he bankrupcy and agency coss associaed wih deb. Whenever firms deviae from heir deb raio, he exisence of adjusmen coss prevens firms from making a oal adjusmen o ha raio, and so Trade-Off Theory forecass ha firms make a parial adjusmen of deb owards he opimal deb raio (López-Gracia, Sogorb-Mira 2008). Adoping he perspecive of Trade-Off Theory, he following research hypohesis is formulaed: Hypohesis 9: SMEs adjus heir level of deb owards he opimal deb raio Pecking order heory research hypoheses According o he Pecking Order Theory, firms may be financially consrained due o he informaion asymmery beween managers/owners and invesors, and so firms adop a hierarchy in selecing sources of finance. In he firs place, firms use reained profis; if i is necessary o urn o exernal finance, firms use deb wih lile or no risk, which usually corresponds o shor-erm deb; and in he las place, firms will selec exernal equiy. The more profiable is he firm, he greaer is is capaciy o accumulae reained profis, and so here is less need o urn o exernal finance. A negaive relaionship is herefore expeced beween profiabiliy and deb, in accordance wih he Pecking Order approach, as idenified in various sudies (Sogorb-Mira 2005; Ramalho, Silva 2009; González, González 2012). On he basis of he anerior exposiion, i is formulaed he following hypohesis: Hypohesis 10: There is a negaive relaionship beween profiabiliy and deb in SMEs. In accordance wih he Pecking Order Theory, firms wih high growh opporuniies mus underake major invesmen projecs, which generae greaer needs for finance. When inernal finance is exhaused, firms prefer deb raher han exernal equiy for funding growh opporuniies, which are associaed wih a greaer risk han do invesmen in asses in place (Shyam-Sunder, Myers 1999; Ramalho, Silva 2009). These auhors sae ha firms wih good growh opporuniies increase deb when inernal funds are insufficien. Therefore, Pecking Order Theory forecass a posiive relaionship beween growh opporuniies and deb, and so we formulae he following research hypohesis: Hypohesis 11: There is a posiive relaionship beween growh opporuniies and deb in SMEs. Considering ha a higher level of angible asses increases he possibiliy of offering collaerals, lessening problems of informaion asymmery beween SME managers/owners and crediors (Michaelas e al. 1999; Sogorb-Mira 2005), a posiive relaionship is expeced beween asse angibiliy and deb. According o he Pecking Order approach, we formulae he following research hypohesis: Hypohesis 12: There is a posiive relaionship beween asse angibiliy and level of deb in SMEs. Pecking Order Theory predics ha greaer size allows a firm o accumulae reained earnings, and so less deb is necessary. Therefore, Pecking Order Theory predics a negaive relaionship beween size and deb (López-Gracia, Sogorb-Mira 2008). According o Myers (1984), greaer firm size lessens he problems of informaion asymmery beween managers/owners and crediors, allowing firms o obain deb on more favourable erms. A posiive relaionship beween size and deb may be expeced in he Pecking Order approach (Psillaki, Daskalakis 2009). According o Pecking Order Theory, he relaionship beween size and deb can be posiive or negaive, and so he following research hypohesis is formulaed. Hypohesis 13: There is a posiive/negaive relaionship beween size and deb in SMEs. According o La Rocca e al. (2011), he Pecking Order Theory is a useful ool for he analysis of he financing behaviour of firms along he life cycle. According o Pecking Order Theory, older firms have a 3

4 greaer capaciy o reain and accumulae earnings, and so he need o resor o exernal financing o solve heir financing requiremens will be less han in he case of younger SMEs. The likelihood of old SMEs o reain profis over ime is considerable, so he older SMEs diminish he recourse o deb. Considering he above, he following hypohesis is formulaed: Hypohesis 14: There is a negaive relaionship beween age and deb in SMEs. 2. Mehodology 2.1. Daabase The firms of he sample of his sudy are non-financial SMEs belonging o he inerior region of Porugal, more precisely o he Beira Inerior region. Daa was gahered from he Sysem Analysis of Iberian Balance Shees daabase (SABI), supplied by Bureau van Dijk, for he period 1998 o The SABI conains he balance shees and income saemens of Poruguese firms. We selec he firms on he basis of he European Union recommendaion L124/36 (2003/361/CE). According o his recommendaion, a business uni is considered an SME when i mees wo of he following crieria: i) fewer han 250 employees; ii) asses under 43 million Euros; iii) business urnover under 50 million Euros. The final sample is composed by 53 SMEs wih daa colleced for he period 1998 o 2005, obaining a oal of 371 observaions Variables The choice of variables and respecive proxies was based on previous sudies, such as Timan and Wessels (1988); Michaelas e al. (1999); De Miguel and Pindado (2001); Sogorb-Mira (2005); Ramalho and Silva (2009); González and González (2012), and Serrasqueiro and Maçãs Nunes (2012). The following able presens he variables o be used in his sudy, ogeher wih heir corresponding measures. (Inser Table 1 Abou Here) 2.3. Esimaion mehod Blundell and Bond (1998) conclude ha use of he GMM sysem esimaor is clearly appropriae, when he dependen variable is persisen, i.e., when here is a srong correlaion beween deb in he presen and previous periods, avoiding bias in he esimaed resuls. Firm s deb is associaed wih high persisency, wih a high correlaion beween deb in he presen and previous periods. This being so, use of he GMM sysem esimaor is he mos appropriae way o esimae he deerminans of firm deb, raher han using he GMM and Anderson and Hsiao esimaors. However, use of he GMM sysem esimaor by Blundell and Bond (1998) implies a considerable number of insrumenal variables, and may lead o resul bias when daabases are no very large, as is he case here. Therefore, use of he LSDVC esimaor by Bruno (2005) is considered o be suiable for he daabase used in his sudy, since i is an appropriae esimaor, for correcing resuls obained wih oher dynamic esimaors, when daabases are no very large. In his sudy, we choose o presen he resuls obained wih he LSDVC (2005) esimaor, for correcion of he resuls obained wih he GMM, GMM sysem and Anderson and Hsiao esimaors. Since our objecive is o esimae he adjusmen of acual SME deb owards he opimal deb level, as well as he relaionships beween deerminans and deb forecas by Trade-Off and Pecking Order Theories, we urn o he parial adjusmen model, jus as López-Gracia and Sánchez-Andújar (2007) and López-Gracia and Sogorb-Mira (2008). The parial adjusmen model is given by: Lev Lev Lev * Lev ), (1) i, i, 1 ( i, i, 1 in which: Lev i, is he deb of firm i in he period ; Lev i, 1 is he deb of firm i in he period 1; Lev i, * is he deb raio of firm i in period and is he speed of adjusmen of acual level of deb owards he opimal deb raio. In he curren sudy, as he majoriy of sudies abou capial srucure decisions (e. g. López-Gracia, Sánchez-Andújar 2007; López-Gracia, Sogorb-Mira 2008), we consider ha he opimal level of deb depends on he firms specific characerisics, and on he macroeconomic condiions (i.e. measured by annual dummy variables) as well as on he firms unobservable specific characerisics (i.e. measured by u i ). Consequenly, we avoid he siuaion of deb no being consan for differen firms and/or for differen periods, bu assuring ha deb varies for each firm and for each period, which is more admissible, in a heoreical perspecive. Furhermore, i is worhwhile highlighing o refer ha Shyam-Sunder and Myers (1999) obained resuls ha, regarding he adjusmen of acual level of deb owards he opimal level of deb, and he relaionships beween deerminans and deb, do no suffer considerable aleraions as a 4

5 funcion of he way of deerminaion of he level of deb. On he basis of he anerior exposiion, firms opimal deb raio is given by: 8 Lev Z d u v, (2) i, * in which K K 1 Z K i, k, i, i i,, is he deerminan k (ERT i, ; NDTS i, ; PROF i, ; GO i, ; TANG i, ; SIZE i, ; AGE i, ; EVOL i, ) of he book value of he deb of firm i a ime, K are he coefficiens of each deb deerminan, d are he emporal dummy variables, u i are individual non-observable effecs, and v i, is he error erm. Subsiuing (2) in (1) and regrouping he erms, we have: Lev i, Lev Z, (3) 0 i, 1 K K 1 0 (1 K 8 k, i, i i, in which: ), K, d, i ui, and i, v i,. The lower he value of 0, he greaer will be, i.e., he greaer he adjusmen of acual SME deb owards he opimal deb raio. The higher he value of 0, he lower will be, i.e., he lower he adjusmen of acual SME deb owards he opimal deb raio. 3. Resuls and Discussions 3.1. Resuls The descripive saisics of he sample considered in his sudy are presened in Table 2. (Inser Table 2 Abou Here) Analysis of he descripive saisics (Table 2) suggess ha he average deb of SMEs is I is also of noe ha he deb of SMEs, considered in he sample, presens a minimum value of and reaches a maximum value of These figures sugges ha a considerable number of SMEs have deb as heir main source of finance. We can also menion ha on average firm size is approximaely Euros, and ha he average age of SMEs is approximaely 17 years. The profiabiliy of SMEs is low, wih an average value of We also conclude ha he volailiy of some variables is high, because for mos of hem he sandard deviaion is greaer han he respecive mean. More precisely, he variables effecive ax rae, growh opporuniies, profiabiliy, and risk are found o presen grea volailiy. The able A1 in Appendix presens he correlaion marix of he variables used in his sudy. All correlaions coefficiens beween independen variables are no above 50%, and so he problem of collineariy beween independen variables will no be paricularly relevan in his sudy (Gujarai, Porer, 2010) The following able presens he resuls obained from applicaion of he LSDVC dynamic esimaor by Bruno (2005), o correc he resuls esimaed wih he GMM, GMM sysem, and Anderson and Hsiao dynamic esimaors. (Inser Table 3 Abou Here) 3.2. Discussions of he resuls The empirical resuls obained wih he LSDVC esimaor by Bruno (2005) allow no rejec/rejec he previously formulaed research hypoheses o deermine if Trade-Off and Pecking Order Theories are followed by SME in heir capial srucure decisions. We idenify saisically insignifican relaionships beween he facors deerminans effecive ax rae, non-deb ax shields, and deb in SMEs, and so he Hypohesis 1 and Hypohesis 2, respecively, are rejeced. These resuls indicae ha he managers/owners of SMEs do no reduce he firm s level of deb due o he possibiliy of obaining non-deb ax shields. Therefore, he financing behaviour of SMEs does no agree wih he forecass of Trade-Off Theory. Michaelas e al. (1999) idenify a negaive relaionship beween effecive ax rae and deb for SMEs in he Unied Kingdom. However, Sogorb-Mira (2005) for Spanish SMEs and Michaelas e al. (1999) for Briish SMEs find a negaive relaionship beween nondeb ax shields and deb, which is according o he forecass of Trade-Off Theory. The negaive and saisically significan relaionship beween profiabiliy and deb in SMEs implies he rejecion of Hypohesis 3, formulaed wih regard o Trade-Off Theory. However, we canno rejec he Hypohesis 10, which predics a negaive relaionship beween hose wo variables. This resul indicaes ha SMEs prefer use inernal finance raher han deb, which agrees wih he assumpions of Pecking 5

6 Order Theory. Various sudies idenify a similar relaionship: Michaelas e al. (1999) for SMEs in he Unied Kingdom; Sogorb-Mira (2005) for Spanish SMEs; Psillaki and Daskalakis (2009) for Greek, French, and Ialian SMEs; Bhaird and Lucey (2010) for Irish SMEs; and La Rocca e al. (2011) for Ialian SMEs. The resuls obained indicae a saisically insignifican relaionship beween growh opporuniies and deb in SMEs. Therefore, we rejec he Hypohesis 4 formulaed in he conex of Trade-Off Theory. Addiionally, we rejec he Hypohesis 11 formulaed in he conex of Pecking Order Theory. Lopéz- Gracia and Sogorb-Mira (2008) obain a negaive relaionship beween growh opporuniies and deb, which agrees wih he forecass of Trade-Off Theory. However, La Rocca e al. (2011) idenify a posiive relaionship beween growh opporuniies and deb for Ialian SMEs, corroboraing he forecass of Pecking Order Theory. The empirical resuls obained indicae a saisically insignifican relaionship beween angibiliy and deb, and so we rejec he Hypoheses 5 and 12, formulaed in he conex of Trade-Off and Pecking Order Theories, respecively. The absence of a posiive and saisically significan relaionship beween asse angibiliy and deb suggess ha angible asses lose imporance for SMEs o obain deb. Probably, SMEs urn above all o shor-erm deb, and so collaerals associaed wih angible asses are no required by crediors. Sogorb-Mira (2005) finds a negaive relaionship beween asse angibiliy and shor-erm deb. We idenify a posiive and saisically significan relaionship beween he variable of size and deb, and so we canno rejec he Hypohesis 6, corroboraing he forecass of Trade-Off Theory. Greaer size allows greaer diversificaion of aciviies in SMEs, which, consequenly, allows a reducion of he likelihood of bankrupcy, and so hese firms increase heir level of deb. Increased size, also, implies a greaer possibiliy of obaining profis, and herefore greaer capaciy o obain deb for aking advanage of he deb ax shields. This fac could be relevan in explaining he posiive relaionship beween size and deb in SMEs. These resuls agree wih he assumpions of Trade-Off Theory. In he conex of Pecking Order Theory, he previously formulaed Hypohesis 13, abou a posiive and saisically significan relaionship beween size and deb in SMEs is no rejeced. Increased size also means fewer problems of informaion asymmery beween owners/managers and crediors, allowing access o deb on more favourable erms. A posiive relaionship beween size and deb was also idenified by Michaelas e al. (1999) for Briish SMEs, Sogorb-Mira (2005) for Spanish SMEs, Psillaki and Daskalakis (2009) for Greek, French, and Poruguese SMEs, Bhaird and Lucey (2010) for Irish SMEs, and by La Rocca e al. (2011) for Ialian SMEs. The negaive and saisically significan relaionship beween age and deb in SMEs implies o rejec he Hypohesis 7, in he conex of Trade-Off Theory. However, ha relaionship allows us no o rejec he Hypohesis 14 in he conex of Pecking Order Theory. Reenion of profis ends o increase wih greaer firm s age, and so he need o resor o deb is less. Addiionally, a negaive relaionship beween age and deb was idenified by Michaelas e al. (1999) for Briish SMEs, Bhaird and Lucey (2010) for Irish SMEs, and La Rocca e al. (2011) for Ialian SMEs. The posiive and saisically insignifican relaionship beween risk and deb in SMEs allows us o rejec he Hypohesis 8. This resul implies ha we canno claim ha SMEs follow he assumpions prediced by Trade-Off Theory. Michaelas e al. (1999) also found evidence of a posiive and saisically significan relaionship beween risk and deb in Briish SMEs. However, a negaive and saisically significan relaionship beween hose wo variables was found by Sogorb-Mira (2005) for Spanish SMEs, Psillaki and Daskalakis (2009) for Greek SMEs, and Poruguese SMEs. Regarding he speed of adjusmen of acual deb owards he opimal deb raio, irrespecive of using he LSDVC dynamic esimaor o correc he resuls of he GMM, GMM sysem, and Anderson and Hsiao dynamic esimaors, SMEs are found o make a considerable adjusmen owards he opimal deb raio. Table 4 presens he values of he esimaed adjusmens. (Inser Table 4 Abou Here) The resuls sugges ha firms adjus heir acual deb level owards he opimal deb raio, which agrees wih he assumpions of Trade-Off Theory. Therefore, we canno rejec he Hypohesis 9. The maximum adjusmen value obained is , from applicaion of he LSDCV (2005) (AH) dynamic esimaor, and he minimum value obained is , from applicaion of he LSDVC (2005) (BB) dynamic esimaor. Alhough considering quoed large firms, Kremp e al. (1999) obain values of 0.53 and 0.28 for Germany, Shyam-Sunder and Myers (1999) 0.59 for he Unied Saes and De Miguel and Pindado (2001) 0.79 for Spain. The figures obained in his sudy are similar o hose obained in he above menioned sudies, suggesing ha he adjusmen coss are lower han he coss 6

7 associaed wih an unbalanced capial srucure for SMEs. Therefore, Poruguese SMEs appear o have a relaively fas speed of adjusmen of heir acual level of deb owards he opimal deb raio. Summarizing, he negaive and saisically significan relaionships obained in he curren sudy beween he independen variables of profiabiliy and age, and he dependen variable of deb, are consisen wih he assumpions of Pecking Order Theory. However, he posiive and saisically significan relaionship beween size and deb allows us o validae he assumpions made by boh Trade- Off and Pecking Order Theories. We, also, conclude ha SMEs make a rapid adjusmen of heir acual deb owards he opimal deb raio. This resul reinforces he conclusion, already referred o, ha Trade- Off and Pecking Order Theories are no muually exclusive. Conclusions, limiaions and suggesions for fuure research Based on a sample of Small and Medium-Sized Enerprises (SMEs) locaed in he inerior region of Porugal for he period , using he LSDVC dynamic esimaor as mehod of esimaion, his sudy ess wheher he capial srucure decisions of SMEs are closer o he assumpions of Trade-Off Theory or o hose of Pecking Order Theory. On he one hand, SMEs make considerable adjusmen of heir acual deb owards he opimal level of deb, and size conribues o increased recourse o deb. These resuls corroborae he assumpions of Trade-Off Theory. More profiable, older SMEs urn less o deb, bu hey increase he level of deb as a funcion of heir size. These resuls corroborae he forecass of Pecking Order Theory. In general, he resuls sugges ha Pecking Order and Trade-Off Theories are no muually exclusive in explaining he capial srucure decisions of SMEs. Considering ha Beira Inerior is a relaively disadvanaged inerior region of Porugal in he conex of he naional economy, where SMEs are especially imporan for increased employmen and economic growh, we sugges ha policy-makers should give effecive suppor hrough favourable erms o hese SMEs in obaining deb. In ha way, when inernal finance is insufficien, young and small SMEs could urn o exernal finance on advanageous erms, allowing hese firms o finance efficienly heir aciviies. A limiaion of his sudy is he fac of analyzing only relaionships beween deerminans and oal deb. SMEs are very dependen on shor-erm deb, which may imply differences beween he level of adjusmen of shor-erm raio and long erm raio owards he respecive opimal deb raios. Therefore, we sugges for fuure research o separae oal deb ino shor and long-erm deb, o analyse he differences beween he level of adjusmen of shor-erm deb and he level of adjusmen of long-erm deb owards he respecive opimal levels. Acknowledgemens The auhors are graeful for financial suppor of Poruguese FCT Projec PTDC/EGE- GES/116004/2009. Funding. References Álvarez-Herranz, A.; Valencia-De-Lara, P.; Marínez-Ruiz, M How enrepreneurial characerisics influence company creaion: a cross-naional sudy of 22 counries esed wih panel daa, Journal of Business Economics and Managemen 12: hp://dx.doi.org/ / Anderson, T.; Hsiao, C Esimaion of dynamic models wih error componens, Journal of he American Saisical Associaion 76: hp://dx.doi.org/ / Ang, J Small business uniqueness & he heory of financial managemen, Journal of Small Business Finance 1: Arellano, M.; Bond, S Some ess of specificaion for panel daa: Mone Carlo evidence and an applicaion o employmen equaions, Review of Economic Sudies 58: hp://dx.doi.org/ / Bhaird, C.; Lucey, B Deerminans of capial srucure in Irish SMEs, Small Business Economics 35: hp://dx.doi.org/ /s Bisrova, J.; Lace, N.; Peleckienė, V The influence of capial srucure on Balic corporae performance, Journal of Business Economics and Managemen 12: hp://dx.doi.org/ / Blundell, M.; Bond, S Iniial condiions and momen resricions in dynamic panel daa models, Journal of Economerics 87: hp://dx.doi.org/ /s (98)

8 Bruno, G Approximaing he bias of LSDV esimaor for dynamic unbalanced panel daa models, Economic Leers 87: hp://dx.doi.org/ /j.econle De Miguel, A.; Pindado, J Deerminans of capial srucure: new evidence from Spanish panel daa, Journal of Corporae Finance 7: hp://dx.doi.org/ /s (00) DeAngelo, H.; Masulis, R Capial srucure under corporae and personal axaion, Journal of Financial Economics 8: hp://dx.doi.org/ / x(80) Fama, E.; French, K Tesing Trade-Off and Pecking Order predicions abou dividends and deb, The Review of Financial Sudies 15: hp://dx.doi.org/ /rfs/ González, V.; González, F Firm size and capial srucure: evidence using dynamic panel daa, Applied Economics 44: hp://dx.doi.org/ / Gujarai, D.; Porer, D Essenials of economerics. 4 h ed. New York: McGraw Hill Inernaional. Jordan, J.; Lowe, J.; Taylor, P Sraegy and financial policy in U.K. small firms, Journal of Business Finance and Accouning 25: hp://dx.doi.org/ / Kremp, E.; Söss E.; Gerdesmeier, D Esimaion of a deb funcion: evidence form French and German firm panel daa, in: A. Sauve, M. Scheuer, H. Friderichs (Eds.). Corporae finance in Germany and France. Frankfur am Main: Deusche Bundesbank, La Rocca, M.; La Rocca, T.; Cariola, A Capial srucure decisions during a firm s life cycle, Small Business Economics 37: hp://dx.doi.org/ /s z López-Gracia, J.; Sánchez-Andújar, S Financial srucure of he family business: evidence from a group of small Spanish firms, Family Business Review 20: hp://dx.doi.org/ /j x Lopéz-Gracia, J; Sogorb-Mira, F Tesing Trade-Off and Pecking Order heories financing SMEs, Small Business Economics 38: hp://dx.doi.org/ /s Michaelas, N.; Chienden, F.; Pouziouris, P Financial policy and capial srucure choice in U.K. SMEs: empirical evidence from company panel daa, Small Business Economics 12: hp://dx.doi.org/ /a: Myers, S Deerminans of corporae borrowing, Journal of Financial Economics 5: hp://dx.doi.org/ / x(77) Myers, S The capial srucure puzzle, The Journal of Finance 39: hp://dx.doi.org/ / Psillaki, M.; Daskalakis, N Are he deerminans of capial srucure counry or firm specific?, Small Business Economics 3: hp://dx.doi.org/ /s Ramalho, J.; Silva, J A wo-par fracional regression model for he financial leverage decisions of micro, small, medium and large firms, Quaniaive Finance 9: hp://dx.doi.org/ / Scherr, F.; Hulbur, H The deb mauriy srucure of small firms, Financial Managemen Spring: hp://dx.doi.org/ / Serrasqueiro, Z.; Maçãs Nunes, P Is age a deerminan of financing decisions of SMEs? empirical evidence using panel daa models, Enrepreneurship Theory & Pracice 36: hp://dx.doi.org/ /j x Smih, C.; Sulz, R The deerminans of firms hedging policies, Journal of Financial and Quaniaive Analysis 20: hp://dx.doi.org/ / Sogorb-Mira, F How SME uniqueness affecs capial srucure: evidence from a Spanish daa panel, Small Business Economics 25: hp://dx.doi.org/ /s Shyam-Sunder, L.; Myers, S Tesing saic Trade-off agains Pecking Order models of capial srucure, Journal of Financial Economics 51: hp://dx.doi.org/ /s x(98) Timan, S.; Wessels, R The deerminans of capial srucure choice, The Journal of Finance 43: hp://dx.doi.org/ /j b02585.x Valackienė, A.; Virbickaiė, R Concepualizaion of crisis siuaion in a company, Journal of Business Economics and Managemen 12: hp://dx.doi.org/ / Zélia SERRASQUEIRO, PhD in Managemen, Associae Professor a he Deparmen of Managemen and Economics o Beira Inerior Universiy and Researcher in CEFAGE-UE (Cener for Advanced Sudies in Managemen and Economics). The research ineress are Corporae Finance and Enrepreneurial Finance. Zélia Serrasqueiro is he auhor of aricles in various journals: Journal of Business Economics and Managemen, Enrepreneurship Theory & Pracice, Research Policy, Journal of 8

9 Evoluionary Economics, Small Business Economics, Indusrial and Corporae Change, Journal of Business Research, Journal of Service Managemen, The Services Indusries Journal, Managemen Research Review, Social Responsibiliy Journal, Review of Accouning and Finance, and oher journals. Ana CAETANO, Maser in Managemen in Beira Inerior Universiy. The research ineress are Corporae Finance and Enrepreneurial Finance. Table A1. Correlaion marix Appendix LEV i, ETR i, NDTS i, GO i, TANG i, PROF i, SIZE i, AGE i, EVOL i, LEV i, 1 ETR i, *** 1 NDTS i, ** 1 GO i, TANG i, * *** *** 1 PROF i, *** *** *** 1 SIZE i, *** *** * 1 AGE i, *** *** ** ** ** EVOL i, Noes: 1. *** Significan a 1% level; ** Significan a 5% level; * Significan a 10% level. Table 1. Variables and measuremen Variables Measuremen Dependen Variable Deb (LEV i, ) Raio beween Toal Liabiliies and Toal Asses Independen Variables Effecive Tax Rae (ETR) Non-Deb Tax Shields (NDTS) Raio of Income Tax Paid and Profis Before Taxes and Afer Ineres Raio beween Depreciaions and Toal Asses Growh Opporuniies (GO) Raio beween Inangible Asses and Toal Asses Asses Tangibiliy (TANG) Raio beween Fixed Asses and Toal Asses 9

10 Profiabiliy (PROF) Size (SIZE) Age (AGE) Risk (EVOL) Raio of operaional resuls before ineres and ax o oal asses Logarihm o sales Logarihm of he number of years of firm in exisence Absolue value of percenage change of earnings before ineres, axes and depreciaions Table 2. Descripive saisics Variables Observaions Mean Sand. Desv. Min. Max. LEV i, ETR i, NDTS i, GO i, TANG i, PROF i, SIZE i, AGE i, EVOL i, Table 3. Deb deerminans LSDVC (2005) dynamic esimaor Dependen Variable: LEV i, Independen Variables LSDVC (2005) Iniial (AB) LSDVC (2005) Iniial (BB) LSDVC (2005) Iniial (AH) LEV i, *** *** *** ( ) ( ) ( ) ETR i, ( ) ( ) ( ) NDTS i, ( ) ( ) ( ) GO i, ( ) ( ) ( ) TANG i, ( ) ( ) ( ) PROF i, *** *** *** ( ) ( ) ( ) SIZE i, ** ** ** 10

11 ( ) ( ) ( ) AGE i, *** ** *** ( ) ( ) ( ) EVOL i, ( ) ( ) ( ) Firms Observaions Noes: 1. Sandard Desviaions in parenhesis. 2. *** Significan a 1% level; ** Significan a 5% level. 3. Iniial (AB) Correcion of GMM dynamic esimaor resuls; Iniial (BB) Correcion of GMM Sysem dynamic esimaor resuls; Iniial (AH) Correcion of Anderson-Hsiao dynamic esimaor resuls. 4. The esimaes include ime dummy variables bu no show. Table 4. Deb adjusmen speed LSDVC (2005) I (AB) LSDVC (2005) I (BB) LSDVC (2005) I (AH) Adjusmen Speed Noes: Iniial (AB) Correcion of GMM dynamic esimaor resuls; Iniial (BB) Correcion of GMM Sysem dynamic esimaor resuls; Iniial (AH) Correcion of Anderson-Hsiao dynamic esimaor resuls. 11