A model of capital structure decision making in small firms

Although earlier capital structure theories, grounded within the finance paradigm (agency theory, transaction cost theory etc), have contributed to a deeper understanding of the capital structure puzzle, recent efforts suggest that research for the missing pieces of the puzzle should continue. This paper considers that these missing pieces of the puzzle could be diverse non‐financial and behavioural factors influencing capital structure decisions, that have received relatively little attention from finance researchers. The paper reports on an exploratory attempt to use interview techniques for the study of capital structure in small firms. Interviews can provide evidence about non‐financial and behavioural variables that quantitative analysis cannot. The paper develops a model for understanding capital structure decision making in small firms. It analyses the responses of small business owners/managers concerning the management of the financial structure of their firms and the factors that influence their capital structure decisions. Small business owners’ responses indicate that although a number of different financial variables may affect their capital structure decisions, other non‐financial and behavioural factors such as the need for control, risk propensity, experience, knowledge and goals may be more important in influencing the capital structure of their firms, at any time. The results indicate that significant progress in understanding the factors that influence capital structure may be achieved if financial researchers incorporate management theory in their studies, so that financial as well as non‐financial and behavioural factors are explored.