FirstPreviousNextLast

Gaps in SME Financing: An Analytical Framework

Summary and Discussion

This document presented a review of the empirical and theoretical literature on market failures, gaps, and imperfections. On the basis of this review hypotheses were articulated that relate to various perceptions of financing gaps that pertain to SMEs. This report then proposed an analytical framework to investigate the presence of gaps that would make use of data collected under the terms of the Financing Data Initiative currently being undertaken by Industry Canada, the Department of Finance, and Statistics Canada. As such, this report is the final stage of a study that examines existing research to identify imperfections, discrepancies, and potential failures in the financial marketplaces in which SMEs must operate. The goals were to advise Industry Canada and its partners with respect to data collection methodologies and analyses of data. To accomplish the objectives, each of the major sectors of the capital markets in which SMEs operate were reviewed. For each segment, this study:

1. examined the research and professional literature to ascertain the extent to which imperfections in that segment of the market had been identified;
2. advanced a series of hypotheses regarding gaps or imperfections in the various segments of the financial markets. The hypotheses were articulated to form a basis for empirical testing using data from the Financing Data Initiative.
3. designed a gap analysis framework and identified methodologies intended to help ascertain the existence and importance of gaps, imperfections, and market failures in the Canadian context;
4. reviewed the current state of the Financing Data Initiative to determine the extent to which the initiative is likely to be able to identify gaps in the particular segment; and,
5. suggested changes to aspects of the Financing Data Initiative that will more effectively document potential market gaps.

The hypotheses generated are listed for convenience below, along with suggested means of testing each.

The Markets for Debt

The Markets for Equity

Possible Future Directions for the SME FDI

The baseline survey associated with the SME FDI is an extraordinarily valuable research initiative. It provides the potential to assess directly the extent to which financing gaps might occur in the capital markets on which SMEs rely. This is an important issue in practical terms, in terms of the role of public policy, and in terms of economic and finance theory. The SME FDI baseline survey data provides, for the first time internationally, a means of empirically testing Nobel prize-winning ideas related to information asymmetry and capital rationing. The data provides a means of providing yet better guidance for public policy with respect to addressing potential capital market imperfections that might constrain growth and economic development of SMEs. As designed, the research initiative can and will provide valuable information about these issues.

To derive this information, it is essential that analysis of the data be conducted carefully and, to the extent possible, in ways that provide for unambiguous conclusions. The baseline survey data has several extremely positive features. First, the data are as random a sample of a population of business enterprises as is possible to collect anywhere in the world. Second, through the knowledge and experience of Industry Canada, Finance Canada and Statistics Canada, a comprehensive questionnaire has been designed and data collected in a rigorous manner. Third, the response rate far exceed that typical of surveys conducted by the private sector, arguably eliminating selection and non-response biases. The implications of this effort include that the expense of collecting these data, its quality, and the issues at hand are simply too great to leave to a superficial (and perhaps misleading) analysis.

With this in mind, this study presents a comprehensive review of the theoretical and empirical literature of the issues that relate to this endeavor. It develops testable hypotheses that relate to the issues at hand and presents a variety of empirical tools and approaches for using the SME FDI data to address the issues. Ultimately, as with all such empirical analysis, success will depend on the knowledge and vision of the analyst and the available quantity and quality of responses to the survey.

Several suggestions are presently offered with a view to making an extremely valuable start to this work even more useful.

Add questions regarding human capital. The literature is consistent in its findings that the human element in all financing decisions is crucial. Without a yet better sense of the education, experience, and other attributes of the owners and managers of the firms, models of access to capital may be susceptible to biases arising from missing variables.

Add questions to fill the gaps in Table 9. Table 9 reflects previous research findings with respect to determinants of access to and terms of credit. As usual, there is a tradeoff between length of questionnaire and usefulness of the results. This initial administration of the baseline survey will identify which questions might be less informative than others. The inherent iterative nature of such research will allow revision of the questionnaire such that some questions might be removed and others added. Table 9 and the associated review of the research literature provides some guidance to this process.

Focus on growth firms. Use successive samples of future surveys to increase the numbers of firms seeking equity capital. Previous research has shown that rapid growth is characteristic of a very small fraction of businesses and that the owners of many firms do not seek growth at all. It is therefore suggested that future administrations of the SME FDI surveys successively retain growth oriented firms so that, after several administrations, the sample will be relatively richer in terms of the numbers of firms most likely to seek expansion and equity capital. The literature suggests that it is the expansion of such firms that are most central to national economic welfare and that the financing problems faced by such firms are arguably those where public policy remediation might be most beneficial.

Undertake longitudinal analysis. Only through ongoing follow-up (even applied to subsets of firms that had been included as part of the baseline survey) can the consequences of financing or turndowns be assessed. Particular issues that are related to longitudinal assessment include:

• assessments of the economic impact of loan guarantee programs and other public policy interventions (survival rates, growth trajectories) through longitudinal follow-up of firms using loan guarantees (or other interventions) with a control group of businesses (can now be carefully designed through the use of comparable firm demographics derived from baseline survey data);
• documentation of growth and survival trajectories of businesses seeking (successfully and unsuccessfully) various forms of equity capital;
• development of in-depth case histories of business development and financing experiences;
• investigation of the linkages between business evolution and the ownership structure and managerial and innovative capabilities of the ownership teams;

Overall, the SME FDI is currently an extremely valuable initiative. Through appropriate and careful analysis of the data public policy can be directed, yet more efficiently, to further improve competitive advantage of Canada's SMEs. Analysis of these data may allow for the resolution of several long-standing contentious issues with which policy makers, researchers, lobby groups, and, indeed, SME owners have had to wrestle.

FirstPreviousNextLast