Does the Capital Structure of New Ventures Differ as a Response to a Financial Crisis?: Capital Structure Responsiveness of Portuguese New Ventures to an Economic Downturn

Introduction

Access to finance and the choice of capital structure are pivotal issues for all firms and, thus, have attracted considerable attention from scholars and motivated a large body of theoretical and empirical studies (Kumar, Colombage & Rao, 2017). The theoretical roots of this literature date back to Modigliani and Miller’s (1958) capital structure theory, arguing that the value of a firm is not affected by capital structure choices and that the cost of capital is unaltered when changing the proportion of debt and equity held by the company. However, some theorists point out the shortcomings of these assumptions, and new capital structure theories have emerged, expanding the range of capital structure topics and proposing several capital structure determinants (Graham & Leary, 2011).

On the one hand, tradeoff theory (ToT) (e.g., Scott, 1972; Kraus and Litzenberger, 1973; Frank & Goyal, 2009) argues that firms seek to reach an optimal level of debt, balancing the costs (direct and indirect costs of financial distress) and benefits of debt (tax savings and reducing agency conflicts between managers and owners). On the other hand, pecking order theory (PoT) (e.g., Myers & Majluf, 1984) argues that managers are better informed than outsiders about firm capabilities and prospects, or in other words, information asymmetry exists. As such, there is a hierarchy of preference for financing, favoring the use of internal finance.

Despite the various studies carried out on the determinants of financial decisions and capital structure, the vast amount of evidence comes mainly from studies that focus on large listed firms (e.g., Titman & Wessels, 1988; Rajan & Zingales, 1995; Harrison & Widjaja, 2014) or on small and medium-sized enterprises (SMEs) (e.g., Van der Wijst & Thurik, 1993; Chittenden, Hall & Hutchinson, 1996; Michaelas, Chittenden, Poutziouris, 1999; Sogorb-Mira, 2005). However, little attention has been paid to new ventures (e.g., Chandler & Hanks, 1998; Cassar, 2004; Örtqvist, Masli, Rahman & Selvarajah, 2006).

Additionally, to date, only seldomly related studies consider the financial context that may affect and condition access to finance decisions. Past studies have shown that macroeconomic conditions affect capital structure decisions (Korajczyk & Levy, 2003). One type of event that undoubtedly affects access to finance is a financial crisis, such the one that began in late 2007 in the US and spread worldwide at different paces and intensities (Campello, Graham & Harvey, 2010). This crisis caused considerable disruption to markets and financial institutions (D’Amato, 2019), most evidently in terms of access to and conditions of credit (Campello et al., 2010; Daskalakis, Balios, Dalla, 2017). Access to credit was very limited (Ivashina & Scharfstein, 2010; European Central Bank - ECB, 2013; Carbo‐Valverde, Rodriguez‐Fernandez & Udell, 2016), and the cost of such financing increased sharply (Santos, 2011), particularly for smaller firms (Serrasqueiro, Leitão & Smallbone, 2018). This situation poses constraints to those firms that rely heavily on bank loans as a means of financing (e.g., DeYoung, Gron, Torna, & Winton, 2015; Thakor, 2015). The difficulties were more accentuated for smaller and younger firms (Cowling, Liu, Ledger, 2012), which led to a decrease in the debt levels of SMEs during the crisis (Proença, Laureano & Laureano, 2014). Additionally, firms also experienced constraints and difficulties, such as a decrease in both revenue and growth opportunities. Such uncertainty affected cash flows and, consequently, impacted the capital structure (D’Amato, 2019).