Chapter 8: Small Business and Liquidity Constraint

Small businesses differ from bigger businesses in important ways. One of the “stylized facts” mentioned in Chapter 2 is that “efficient markets” hypothesis does not seem to apply to small businesses. On the other hand, it is often said that small businesses sometimes cannot get access to capital funds even though their business plans could be profitable. Some research on small business has observed that small closely-held businesses often have definite preferences as to how they might raise capital. This is called the “Pecking Order Hypothesis” (e.g. Koropp et al., 2012). The Pecking Order Hypothesis is that a closely held firm will predictably prefer internal finance to borrowing but prefer borrowing to share issues that would dilute the close control. Thus, where internal finance is insufficient, borrowing may play a strategic role, and limits to the firm’s access to loan capital may be a particular strategic handicap…