CUADRO N° 64 TIENDAS

One of the more influential ideas in the finance literature is the pecking order theory of capital structure choice, which posits the emergence of a hierarchical order based on the presence of information asymmetries between companies and their potential financiers (Myers and Majluf, 1984). According to this framework, informational asymmetry arises when managers have more complete information about an investment opportunity than do the investors who are being asked for funding. Such asymmetries may become serious issues and result in adverse selec- tion problems (Akerlof, 1970) or in moral hazard (de Meza and Webb, 1987). The former reduces the accuracy with which the investor can assess the quality of a company, while the latter refers to the situation that exists when managers misuse issued funds for personal gain. As a result, investors may demand a premium in exchange for capital due to this informational opacity – and the more risky the investment, the higher the premium will be, since risk intensifies the effects of information asymmetry (Myers, 1984). Consequently, external finance is costly, and as a result, managers prefer to finance new investments with internal funding whenever possible. Only when internal funds are insufficient to meet a firm’s finan- cing needs will managers turn to more expensive outside funds. Of the external sources, the theory stipulates that debt financing is preferred to equity, since the former will be less exposed to information asymmetries and hence is subject to lower premiums (Myers, 1984; Myers and Majluf, 1984). This hierarchy is referred to as a financial pecking order.

While the pecking order theory was originally developed to explain financial strategies of large and mature companies, scholars have investigated whether the theory is also applicable to young and small ventures. Given that such firms have a set of characteristics that distinguish them from large corporations, it is not immediately obvious that these ideas are fully applicable to the small firm (Cassar, 2004). Compared to larger, especially listed, companies, startup firms have: (i) limited histories and thereby no track records, (ii) no reputation at stake, (iii) limited tangible assets and thereby limited ability to offer guarantees, (iv) inherent uncertainty due to the innovation process, (v) less stringent rules regarding information disclosure, (vi) ownership that is often concentrated in the hand of the founders, and, (vii) significantly higher failure rates (Audretsch and Stephan, 1996; Berger and Udell, 1998; Cassar, 2004; Cressy, 2006; Huyghebaert and Van de Gucht, 2007). Taken together, startup firms are arguably the most informationally opaque type of businesses in the economy and, therefore, face

extraordinarily severe information asymmetry problems (Berger and Udell, 1998; Cassar, 2004). Given this fact, in addition to the small scale of entrepreneurial projects, the widespread belief is that investing in young and small companies is expensive. Therefore, the premium for external funding is expected to be high for startup firms.

Consequently, several scholars acknowledge that the traditional pecking order hierarchy also applies well to startup firms. Just as larger companies, small and emerging firms prefer to finance new projects with internal means, and thereafter, if necessary, to seek external debt capital, only seeking expensive external equity as a last resort, given the high costs associated with giving up ownership stakes (Berger and Udell, 1998; Huyghebaert and Van de Gucht, 2007; Vanacker and Manigart, 2010). Hence, the use of external equity funding could be a signal of low firm quality since this is a last resort for most firms. Other scholars, however, maintain that the traditional pecking order is reversed for entrepreneurial firms for two reasons. First, the rank order is likely to be distorted if the investors have superior knowledge about the commercialization prospects of an entrepreneur’s innovation. For example, Garmaise (2001) shows that when investors are known to possess a greater ability to assess project quality relative to that of the entre- preneurial team, external equity finance will instead be indicative of a high-quality firm. Second, external equity may also be ranked higher if investors are able to add not only capital but also non-monetary value to their investee firms (Garmaise, 2001; Carpenter and Petersen, 2002).

Another theoretical model used to investigate the determinants of com- pany capital structures is the life cycle paradigm, which examines how the use of funding changes over time (Berger and Udell, 1998). The basic idea is that financial needs and access to funding change as the venture grows, gains more experience and becomes less informationally opaque. According to Berger and Udell (ibid.), smaller and younger firms have to rely more on insider financing, trade credits and angel funding. As they grow, equity finance will also be available from venture capitalists, as will debt capital from banks and other financial institutions. Eventually, if the firm continues to grow, it may gain access to public equity through an IPO. Figure 2.2 presents Berger and Udell’s (ibid.) illustration of the financial growth cycle for small businesses in a somewhat simplified format. This model of how firms are financed has gained significant popularity in business schools and among practitioners. The life cycle approach, however, does not fit all types of small ventures, such as cases where some of the financing alternatives are only available to a small subset of firms, i.e., business angel funding, venture capital and public equity. This is an observation that was also highlighted by Berger and Udell (ibid.), and will be further discussed in subsequent sections.

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Figure 2.2. The financial growth cycle of firms according to Berger and Udell (1998, p. 623), somewhat simplified.

In addition to determinants of capital structures arising from the pecking order and the life cycle theories, other factors related to the characteristics of the founders, firms, and institutions have been highlighted in the literature.