The influence of governance on the capital structure of SMEs in the local apparel productive arrangement Open Access

Small and medium-sized enterprises (SMEs) play a vital role in economic development (Martinez, Scherger, & Guercio, 2019; Czerwonka & Jaworski, 2021), representing 89.9% of formal businesses in Brazil (SEBRAE, 2021). Many operate within Local Productive Arrangements (LPAs), such as the Hinterlands Apparel LPA in Pernambuco, for example. Recognizing its relevance, the state has implemented policies to support its growth (Xavier, 2020). LPAs foster collaboration and collective goals among businesses (Antero, Tavares, Antonialli, & Castro, 2019).

Despite their critical importance, SMEs face greater operational and growth-related challenges than large corporations. They often exhibit management weaknesses, contributing to a high mortality rate of approximately 60.2% within five years (IBGE, 2019). A key challenge is access to external financing, primarily sourced by banks, which are cautious because of perceived risks. Kumar and Rao (2016), analyzing 1,524 SMEs from 2006 to 2013, found a reliance on short-term debt, driven by barriers to long-term credit, such as information asymmetry, credit rationing, and lack of audited financials. Mahlawat and Batra (2020) emphasize that limited transparency is a major obstacle, highlighting the need for clearer financial reporting. This is corroborated by Mwidege (2024), who found that audited financial records are a determinant that influences the decision of financial institutions to finance small businesses.

Transparency, a core principle of good governance, fosters trust in an organization’s relationships with external stakeholders and can enhance access to external financing. (IBGC – Brazilian Institute Corporate Governance, 2014). Teti, Dell’Acqua, Etro, and Resmini (2016) found a negative relationship between corporate governance and the cost of equity capital. According to the authors, good corporate governance standards can reduce agency problems and improve the quality of information flows of companies.

Corporate governance is relevant to all firms seeking transparent and trustworthy relationships with their stakeholders. The adoption of sound governance practices such as accurate accounting, timely disclosure, and the establishment of a boardcan boost lender and investor confidence, mitigate information asymmetry, and improve access to capital.

Adopting good governance practicessuch as proper accounting, information disclosure, and the presence of a boardcan enhance investor and lender confidence, reduce information asymmetry, and improve SMEs’ access to funding. Based on this, the research question is, “How does corporate governance impact the capital structure of small and medium-sized enterprises in the Hinterlands Apparel Local Productive Arrangement in Pernambuco?”

This study investigates how governance mechanisms influence the capital structure of SMEs within the Apparel Local Productive Arrangement in Pernambuco’s hinterlands. Despite the pivotal role of SMEs in local development, especially in emerging markets, little is known about how governance affects credit access in informal and semi-formal contexts. While the existing literature primarily focuses on large corporations, SMEs in LPAs remain underexplored. This gap is particularly evident in Local Productive Arrangements (LPAs), where institutional structures are weak, and transparency mechanisms are underdeveloped. By analyzing the influence of governance mechanisms—especially transparency, accountability, and reporting—on the capital structure of SMEs in a Brazilian apparel LPA, this study addresses this empirical gap and contributes to expanding the applicability of governance theory to less formal and resource-constrained environments.

The literature on SMEs and governance can be divided into three strands: (1) the role of transparency in reducing information asymmetry and improving access to credit (Caneghem & Campenhout, 2012; Erdogan, 2018); (2) the influence of governance structures, such as boards and advisory mechanisms, on firm performance and decision-making (Heuvel, Gils, & Voordeckers, 2006; Karoui, Khlif, & Ingley, 2017); and (3) the determinants of capital structure, particularly under the lens of pecking order and agency theories (Martinez et al., 2019; Kumar & Rao, 2016). This study builds on these strands by jointly examining how governance mechanisms influence credit access in a semi-formal SME context. Unlike much of the literature that focuses on large firms or formal SMEs, this study highlights that even foundational governance practices, such as financial reporting and managerial seriousness, can play a relevant role in improving financing conditions in informal productive arrangements.

Agency problems emerge from conflicts between ownership and control, stemming from managerial opportunism, incomplete contracts, and decision making under uncertainty (Jensen & Meckling, 1976). Although SMEs are often managed by their owners (Hart, 1995), they still experience conflicts with creditors (Panda & Leepsa, 2017), particularly because of the lack of financial disclosure and audited statements. This asymmetry increases agency costs and exposes firms to bankruptcy risks, adverse selection, and moral hazard (Abor & Adjasi, 2007; Santos, Dorow, & Beuren, 2016; Klein & Almeida, 2017) Adverse which occur when borrowers hold hidden information that increases their chances of obtaining credit, leading to credit rationing in the absence of lending regulations (Lazzarini & Chaddad, 2000). Moral hazards arise when loans are used for high-risk, non-contractual activities, and risking default. To mitigate these issues, firms implement governance mechanisms to curb opportunistic behavior. Corporate governance helps monitor SME managers, enhance transparency and accountability, and reduce bank information asymmetry.

Several studies have underscored the importance of financial transparency in improving SMEs’ access to external funding. Caneghem and Campenhout (2010) find that both the quantity and quality of financial disclosures positively affect leverage levels. Similarly, Quintiliani (2019) reports that higher transparency reduces information asymmetry and facilitates optimal capital structure decisions. Erdogan (2018) emphasized that without reliable financial data, banks are unlikely to approve credit, as they require accurate assessments of borrowers’ financial health. Given this framework, it becomes interesting for a company to create a relationship of trust with its capital suppliers because the lack of disclosure or the disclosure of insufficient (amount) information can lead to a poor perception of its performance by the market. Therefore, companies suffer pressures from various stakeholders, which encourage them to disclose sufficient and reliable information (Serra & Lemos, 2020).

Beyond transparency, SMEs can also adopt a Board of Directors as a key governance mechanism (IBGC, 2014). A board plays a significant role in shaping firm outcomes (Heuvel et al., 2006), but its structure should reflect the SME’s specific context and needs (Karoui et al., 2017). Due to limited resources and the overlap between ownership and control, decision making often remains centralized (Kurniawati, Sari, & Kartika, 2018). Thus, empirical research is needed to assess how board roles apply across small business settings (Heuvel et al., 2006).

SMEs with single-tier governance structures often face limitations owing to a lack of managerial expertise. Many decisions are made intuitively, without relying on financial statements or relevant management information (Santos et al., 2016). Consequently, these firms miss the strategic benefit that a properly formed board or a qualified financial manager can support informed decision-making (Gils, 2005). Studies indicate that for Italian SMEs, family councils and informal shareholder meetings are more influential than formal boards of directors (Montemerlo, Gnan, Schulze, & Corbetta, 2004). According to Umrani, Johl, and Ibrahim (2015), decisions in these companies are typically made by family patriarch, reflecting a “top-down” management style. Another approach for SMEs is to hire specialized consultants. Schuster and Friedrich (2017) found that 75% of entrepreneurs believe that business consultancy can improve financial management, particularly when advising on suitable financing arrangements. Additionally, Ralio and Donadone (2015) highlight Sebrae’s support for SMEs in Brazil through management services, although only 33% of the companies utilized these services.

The interaction between governance and financing in Brazil’s apparel SMEs reflects the combined dynamics of the agency theory and pecking order theory. Although many of these businesses are family owned, reduced internal agency conflicts persist in their relationships with banks and suppliers. The lack of formal reporting and governance structures increases asymmetry and agency costs, underscoring the importance of transparency and accountability in mitigating such inefficiencies. Pecking order theory is particularly relevant in the context of the local apparel industry. Business owners tend to favor internal funding because of concerns about control dilution and repayment risks. Additionally, limited access to formal credit resulting from informality and insufficient collateral reinforces this financing hierarchy. Governance practices may help reverse this trend by improving disclosure and reducing lenders’ perceived risks. Beyond formal governance structures, social capital and trust-based relationships play a significant role in shaping financial behavior in SMEs, especially in family run businesses. According to Mertzanis (2019), informal governance mechanisms such as family ties and relational trust significantly influence credit access. In Brazilian LPAs, where management often remains informal, these mechanisms may complement or even substitute for formal governance tools.

Systematic reviews by Singh and Pillai (2021), Handley and Molloy (2022), and Gora and Yadav (2024) reinforce the benefits of corporate governance in small enterprises. Analyzing hundreds of articles, these studies found that governance structures improve access to capital, reduce funding costs, and enhance overall performance. However, they also highlight the need to tailor governance mechanisms to the realities of SMEs. Public policies and government incentives can support its adoption by providing financial and technical assistance.

Capital structure is crucial for SME survival, especially in emerging markets with financial constraints (Martinez et al., 2019). The observed dependence on internal finances by a substantial proportion of the studied MSMEs shows frequent difficulties in obtaining external funding (Mwidege, 2024). The Valor Econômico report, citing the OECD and ECLAC, showed that Brazilian SMEs receive only 12% of the national credit, compared to 25% in developed countries.

Globally, SMEs around the world rely on similar funding sources. In the U.S., 70% of small business capital comes from owners, banks, and suppliers (Berger & Udell, 1998). Access to credit remains limited in India and Turkey, with a preference for short-term debt and internal funds because of banks’ reluctance to offer long-term loans (Abe, Troilo, & Batsaikhan, 2015; Uyar & Guzelyurt, 2015). The Brazilian context reflects this pattern: most entrepreneurs face difficulties in obtaining external funding and rely on retained earnings, bank loans, informal credit, and personal savings (Cavalheiro, Vieira, & Valcanover, 2016). This behavior aligns with the Pecking Order Theory, which emphasizes a preference for internal over external capital (Kumar, Colombage, & Rao, 2017).

Information asymmetry affects financing decisions, as managers and SME owners possess more information than investors and lenders do. This supports a financing hierarchy with retained earnings as the preferred source (Myers & Majluf, 1984). When internal funds are lacking, firms seek debt, which is often ranked by risk (Leary & Roberts, 2010). SMEs may adopt corporate governance practices to lower the cost of external capital, especially during the growth stages.

As a last resort, companies would issue new shares, something not desirable to shareholders, because the announcement of the issuance would be followed by a fall in the price of existing shares (Myers & Majluf, 1984), because of the existence of information asymmetry between managers and investors (Myers & Majluf, 1984). In the case of small businesses, owners point out equity capital as the last option by owners (Holmes & Kent, 1991).

According to Holmes and Kent (1991), micro and small enterprises follow Pecking Order Theory (Myers & Majluf, 1984) in their financing decisions, prioritizing retained earnings, loans, and capital contributions. However, they suggest that this sequence may be mandatory for small businesses driven by the owner’s desire for control and credit limitations. Additionally, a lack of managerial knowledge about debt benefits and costs influences financing decisions.

Norton (1991) observed that high-growth UK SMEs prefer internal financing to avoid diluting ownership and seek external funds only when necessary. Internal characteristics such as asset tangibility are crucial for credit access, as collateral reduces lender risk and supports greater leverage (Kayo & Kimura, 2011). For SMEs, the asset structure helps mitigate information asymmetry and signal credibility in the market (La Rocca, La Rocca, & Cariola, 2011).

Studies on SMEs have shown that the relationship between tangibility and debt depends on the type of debt. Firms typically match fixed assets with long-term debt, and current assets with short-term debt. Due to limited asset structures, SMEs face challenges in accessing long-term credit, relying more on short-term debt (Abor & Adjasi, 2007; Sekyi, Nuako, & Atisu, 2024). Tangible assets positively influence medium- and long-term debt (Delikanlı & Kılıç, 2021), but negatively impact short-term debt (Matias, Baptista, & Salsa, 2015), suggesting that asset availability helps mitigate agency and information asymmetry issues. According to Pecking Order Theory, firms with fewer fixed assets resort more to short-term loans as they face difficulties in accessing external capital (Kokeyeva, Hájek, & Adambekova, 2022).

Bhaird and Lucey (2010) showed that SMEs use fixed assets and, if needed, personal assets as collateral to mitigate information asymmetry. Studies by Correa, Basso, and Nakamura (2013), Henrique, Silva, and Saporito (2021), and Czerwonka and Jaworski (2021) find a negative relationship between liquidity and indebtedness, aligning with the Pecking Order Theory. Henrique et al. (2021) note that Brazilian firms with high liquidity depend less on external funds, and Pereira, Tavares, Pacheco, and Carvalho (2015) observe a similar negative link between liquidity and short-term debt in SMEs.

This study is quantitative, exploratory, and descriptive in nature (Lakatos & Marconi, 2017). It surveyed SMEs registered with the Brazilian Federal Revenue Service in the municipalities of Caruaru, Santa Cruz do Capibaribe, and Toritama, which comprise the core of Pernambuco’s apparel Local Productive Arrangement (LPA). Of the 382 firms contacted, 102 participated, yielding a response rate of 26.7%. The main reason for non-participation was concern over disclosing sensitive business information. According to SEBRAE (2021) and BNDES, small Brazilian companies are those that employ between 20 and 99 people in the industrial sector and have an annual gross revenue above R$ 360,000.00 and up to R$ 4,800,000.00. Medium-sized companies are defined as those with 100 to 499 employees and an annual gross revenue above R$ 4.8 million and up to R$ 300 million. This classification is important for the formulation of public policies, credit granting, and the analysis of the economic profiles of companies in Brazil.

Gross revenue was used to classify company size, as many firms outsource production and lack formal employees, making headcounts a less appropriate, though complementary, criterion. Primary data were collected through a structured questionnaire administered to company managers. The instrument consists of three sections covering social and business characteristics, funding sources, and governance practices. To ensure clarity and content validity, the questionnaire was reviewed by two PhD students, four PhD students, and a local entrepreneur. A pre-test was conducted with four small firms, yielding response times of 20–30 min, leading to minor adjustments.

A Likert scale was employed to assess the degree of governance adoption and perceived importance of various mechanisms in credit applications. Instrument reliability was tested using Cronbach’s alpha, with values above 0.70 considered acceptable. For exploratory research, thresholds above 0.60 may be deemed sufficient (Hair, Hult, Ringle, & Sarstedt, 2013).

Regarding the Capital Structure (CS) of companies, the percentage of success of the company’s bank capital was identified, as shown in Figure 1.

Independent variables included a proxy for three governance mechanisms (transparency, management, and board), along with tangibility and liquidity factors identified in the literature as determinants of capital structure.

The independent variables comprise proxies for three governance dimensions—transparency, management quality, and board structure—as well as asset tangibility and liquidity, which are recognized determinants of capital structure in the literature. The selection of constructions was guided by both theoretical underpinnings from agency and pecking order theories, and empirical evidence emphasizing the role of transparency, reporting, and managerial seriousness in SME financing. However, the cross-sectional nature of the study limits its ability to infer causality or temporal changes in governance adoption. Longitudinal data can provide deeper insights into how governance practices evolve and affect financing decisions over time.

Data analysis employed two complementary techniques: the Mann-Whitney U test and partial least squares structural equation Modeling (PLS-SEM). The Mann-Whitney test was chosen because of the non-normal distribution of the dataset, which included 102 SMEs. This nonparametric method is suitable for comparing two independent groups when the dependent variable is ordinal or lacks normality. In this study, it was used to compare governance-related reporting practices between firms that had secured bank loans and those that had not. PLS-SEM was the primary technique for examining causal relationships between governance mechanisms and credit access. According to Hair, Hult, Ringle, and Sarstedt (2013), this technique is particularly suitable for exploratory research, especially when the theoretical foundations are still being developed and when the objective is to predict rather than confirm theoretical models. Moreover, PLS-SEM is appropriate for small samples (fewer than 100 cases) and for data that do not conform to multivariate normality assumptions, conditions that apply to this study. Its flexibility in handling complex models with latent constructs and multiple indicators, combined with its tolerance for lower explained variances (R²), makes it a methodologically sound choice for social science studies. In this context, PLS-SEM enables the identification and evaluation of structural relationships among governance practices and financial outcomes in resource-constrained SME environments.

Instrument validation followed a multistage process. A pre-test with SME managers assessed the item clarity and relevance. Expert evaluations by two PhDs, four doctoral candidates, and a local entrepreneur ensured content adequacy. Internal consistency analysis, using Cronbach’s alpha, yielded a high score of 0.918. Exploratory Factor Analysis (EFA) demonstrated data suitability, with a The Kaiser-Meyer-Olkin (KMO) of 0.770 and a significant Bartlett’s test of sphericity. Although the sample was drawn from firms within the same LPA, measures were taken to mitigate homogeneity bias. Data were collected from three municipalities to ensure regional variability. Control variables such as tangibility and liquidity were included to account for financial heterogeneity. A comparative analysis of firms with and without bank loans further allowed for the identification of governance-related behavioral differences.

This section presents the profiles of the respondents and their respective companies, based on the first part of the questionnaire. Given the financial nature of the study, the survey targeted individuals with comprehensive knowledge of company operations, preferably the owners or, when unavailable, the general managers. Among the respondents, 75.5% were owners and 24.5% were managers, as shown in Table 1.

The SME managers’ profile revealed that most were owners (75.5%), men (61.8%), with an average age of 37.5, held higher education degrees (48.5%), and had 13.61 years of managerial experience. Companies, mainly in the apparel sector (79.4%), have been in operation for over 13 years, with an average of 13 employees. Most were located in Caruaru (47%) or Santa Cruz do Capibaribe (46%). These are small businesses (92%), with 63.72% having 100% of the capital controlled by a single individual, and 81.37% managed primarily by the owners, especially in the financial sector.

As for the level of education, a growth in the appreciation of academic knowledge can be noticed, since in a previous survey also conducted in the same LPA, only 29% of respondents had started or completed Higher Education (Ramos, Santos, & Vasconcelos, 2017). Therefore, almost half of these companies are run by managers with specialized academic and/or technical experience. Some respondents stated that this reality has been changing even slowly due to the establishment of the Federal University of Pernambuco (UFPE) campus in Caruaru. Moreover, a feature worth noting that was identified by the statements of some managers is that the qualification has intensified in the second generation; that is, the owners’ children are training to take over the company and, today, in some companies, they already occupy the role of managers. Qualification is important because, according to Berisha, Hoti, and Hoti (2023), financial education contributes to decision making regarding capital structure.

In terms of longevity, the data show that 70.6% of the firms have been in operation for at least five years, a critical threshold, according to IBGE (2019). Furthermore, 48.1% survived for over ten years, indicating relative maturity and resilience within the sector.

The purpose of this section is to identify, through the analysis of structural equation modeling, whether governance mechanisms influence the capital structure of SMEs that make up the LPA of apparel manufacturers in the Pernambuco Hinterlands.

The variables were incorporated into the structural equation model based on factors defined by Exploratory Factor Analysis (EFA), including only those with communality >0.60 (Hair, 2009). Statements related to transparency, accountability, and Board of Directors were excluded. The instrument demonstrated high internal consistency, with a Cronbach’s alpha of 0.918. The KMO index was 0.770, and Bartlett’s test of sphericity was significant (χ² = 253.507, p < 0.05), confirming the adequacy of the data for factor analysis. The EFA revealed five governance-related factors: disclosure, seriousness, baseline reports, extra reports, and boards, encompassing a total of 22 items.

In the Structural Equation Modeling (SEM), the initial model used the level of bank indebtedness as the dependent variable. After estimation, model fit was assessed, starting with Convergent Validity, measured by Average Variance Extracted (AVE), where AVE scores should exceed 0.50, for satisfactory convergence (Fornell & Larcker, 1981). Two constructions had AVE scores <0.50, leading to the removal of two variables (extra reports and boards) due to low factor loadings. This exclusion was primarily due to low factor loadings, indicating insufficient contribution to the variance of the construction. Additionally, conceptual overlap with other constructs, such as Seriousness and Baseline Reports, may have diluted their discriminant power, justifying their exclusion from the final model.

After adjusting the model in relation to the AVE, the second step was to ensure Convergent Validity, which is the observation of the internal consistency (Cronbach’s alpha – CA) and Composite Reliability (CC) scores. In both cases, CA and CC were used to assess whether the sample was free of bias or whether the collected answers were reliable. CA scores between 0.60 and 0.70 are considered adequate in exploratory surveys and CC scores from 0.70 to 0.90 are considered satisfactory (Hair et al., 2013). Table 2 shows that the CA and CC scores were adequate.

The third stage is the evaluation of the discriminant validity (DV) of the SEM, which is understood as an indicator that the constructs or latent variables are independent of each other (Hair et al., 2013). There are two ways to observe the cross-loadings: indicators with higher factor loadings on their respective variables than on others (Chin, 1998), and the Fornell and Larcker (1981) criterion, in which the square roots of the AVE must be greater than the correlations between the constructs, which was also met according to the scores described in Table 2.

With the assurance of Discriminant Validity, the adjustments of the measurement models are completed, and the structural model analysis is now begun. The first analysis of this second moment is the evaluation of Pearson’s determination coefficients (R²): R² evaluates the portion of the variance of the endogenous variables, which is explained by the structural model. For the social and behavioral sciences, Cohen (1988) suggests that R² = 2% is classified as a small effect size, R² = 13% as a medium effect size, and R² = 26% as a large effect size, and the size of effect: f² = 0.02 = small; f² = 0.15 = medium; f² = 0.35 = large effect size. The structural model presented in Figure 2 shows an adjusted R² equal of 14.6%. The effect size (f²) was small, as was the explained variance.

Out of the hypotheses identified in the model, three were confirmed, seriousness being (f² = 0.088) and the baseline reports (f² = 0.053), at a 5% level (p < 0.05), with a small effect size for both relations, and the extra reports (f² = 0.047) with a significance of 10%. Among the tested hypotheses, three showed statistical significance: Seriousness and Baseline Reports at the 5% level and Extra Reports at the 10% level. These findings highlight that lenders place greater value on fundamental financial behaviors and formal record-keeping over symbolic governance mechanisms such as board presence. In the case of Extra Reports, although statistically weaker, the result may indicate that excessive or disorganized reporting, possibly reflecting poor financial planning, could raise red flags for lenders. These nuances reveal that quality and consistency in governance practices are more impactful than mere existence.

The results indicate that baseline report availability positively affects SME loan approval (β = 0.268). Despite difficulties in preparing these reports (Klein & Almeida, 2017), many firms submit them to banks, easing credit access. This aligns with studies linking financial information quality to higher SME leverage (Caneghem & Campenhout, 2012). Also corroborated by Mwidege (2024) who indicates, in his research, that audited information is significantly related to greater ease for small companies to obtain financing from financial institutions.

In an attempt to reinforce this result, all companies that did or did not seek bank loans were asked to write some reports. By comparing the two groups, it can be seen that companies that have sought bank loans have made more reports than companies that have never received loans (see Table 3).

Of the nine reports analyzed, eight were predominantly prepared by companies that secured loans. To assess whether a significant difference exists in the number of reports written by companies that did or did not apply for bank loans, we conduct statistical tests. Given the non-normal distribution of variables, we employed the non-parametric Mann-Whitney U test for this analysis.

The results of the Mann-Whitney U test revealed a statistically significant difference between companies that applied for bank loans and those that did not with regard to the number of governance-related reports prepared. Companies that applied for credit (n = 70) had a higher mean rank (56.06) than those that did not seek loans (n = 32), with a mean rank of 41.53. The U value was 801.000, Z score was −2.314, and p-value was 0.021, indicating significance at the 5% level. These findings suggest that companies pursuing bank financing tend to demonstrate greater transparency by producing more reports. This likely contributes to building trust with financial institutions, enabling a better assessment of credit risk and a company’s financial standing. Therefore, report preparation appears to play an important role in facilitating access to bank credit.

The Beta score (0.337, p = 0.009) indicates a positive relationship between financial seriousness and loan approvals. Given the common lack of transparency in SMEs owing to less rigorous bookkeeping, reliable financial information is essential for accessing credit, supporting Erdogan (2018). Seriousness helps reduce agency problems because incomplete or uncertain data can lead to adverse selection (Matias, Baptista, & Salsa, 2015), with borrowers potentially omitting information to obtain loans (Lazzarini & Chaddad, 2000). Thus, providing accurate and complete information is the key to securing bank financing.

Additional reports on credit management show a negative relationship with bank debt, suggesting banks’ reluctance to lend when firms face short-term cash flow gaps. Liquidity and tangibility had a positive but non-significant association with loan approval, while disclosure and board presence had a negative but non-significant relationship. These results highlight the importance of governance, particularly the availability and quality of information, in accessing credit (Caneghem & Campenhout, 2012; Mwidege, 2024). However, SMEs still adopt such practices to a limited extent, reinforcing the need for policies that encourage governance in small businesses (Al-Najjar & Al-Najjar, 2017).

This study examines how governance mechanisms influence the capital structure of small and medium-sized enterprises (SMEs) within the apparel Local Productive Arrangement (LPA) of Pernambuco’s hinterlands. These findings indicate that the adoption of governance practices, particularly financial transparency and accountability, is associated with improved access to bank financing. Although the overall effects are modest, the results suggest that governance mechanisms can reduce information asymmetry and enhance the credibility of SMEs. The results indicate that the adoption of governance practices by small and medium-sized enterprises (SMEs) within the apparel production cluster (LPA) in the Hinterlands of Pernambuco has an influence on their capital structure—particularly by facilitating access to third-party funding, especially from banks transparency and accountability were statistically significant among the governance variables analyzed. Although these variables proved to be relevant determinants of external financing, their overall impact remained modest, suggesting that governance practices in these firms are still at an early stage of development. This was evidenced by the average scores for the variables related to governance, which were 3.394 for transparency and 3.076 for accountability.

The introduction of governance in small businesses is a voluntary commitment; however, progress is already visible. However, barriers to implementation remain, as managers of smaller companies often prioritize day-to-day operations over strategic issues, such as adopting governance and focusing on business continuity instead.

This may help explain why the presence of a board of directors did not emerge as a significant determinant of the capital structure. In many cases, key decisions are concentrated in the hands of the founder or owner-manager. A lack of managerial development and limited familiarity with financial tools can inhibit strategic planning and long-term growth, reducing the perceived value of board structures in these contexts. The tangibility variable, a significant determinant of capital structure in literature, was not relevant in this study. This may be because most companies outsource production (cutting, washing, and sewing), which affects their level of tangibility, which is a common practice in the region where the sample companies are located. Despite these limitations, understanding and implementing governance in small businesses is crucial for their sustainable development as it presents an opportunity to enhance performance and ensure long-term sustainability.

From a theoretical standpoint, this study extends the application of agency theory to informal and semi-formal SMEs within LPAs. Evidence suggests that even in contexts with minimal formal governance, mechanisms such as transparency and financial rigor can help reduce agency costs and facilitate credit access. These findings reinforce the relevance of the governance theory to large or publicly listed firms.

Additionally, the results reinforce pecking order theory in the context of SMEs, highlighting a persistent preference for internal funds due to limited access to formal credit channels. However, this study also shows that governance mechanisms may disrupt this hierarchy by improving trust and reducing lender uncertainty. Thus, this study contributes to bridging the theoretical gap in how SMEs, even in resource-constrained environments, can adopt governance tools to shift financing patterns and improve capital structure outcomes.

Based on these findings, it is recommended that SMEs operating within Local Productive Arrangements (LPAs) gradually adopt fundamental governance practices aimed at increasing financial transparency and credibility. One important step involves training business owners and managers in the preparation of basic financial reports, such as cash flow and income statements, even in simplified formats, with technical assistance from organizations such as SEBRAE.

Additionally, the establishment of minimal accounting routines and the implementation of periodic internal reporting mechanisms for partners and creditors can contribute to reducing information asymmetry and enhancing lender trust. Over time, SMEs could progress toward more structured governance practices, including the appointment of individuals responsible for internal controls, scheduling of formal management meetings, and, where feasible, the creation of advisory boards involving external professionals. These measures would not only improve access to credit but also promote long-term organizational sustainability. Although focused on a Brazilian LPA, the findings resonate with SMEs in other emerging economies facing the similar challenges of informality, credit constraints, and limited governance adoption. Therefore, the evidence presented here may guide international efforts to improve SME financing through practical governance mechanisms, thus enhancing the global relevance of this research.

In addition to the implications for managerial practice, the findings of this study offer insights that may inform public policy design. In particular, the positive relationship observed between governance mechanisms and access to credit highlights opportunities for refining programs such as Simples Nacional, which currently provides simplified tax regimes for micro and small enterprises in Brazil. Policymakers could consider integrating progressive requirements for transparency, such as the submission of simplified financial statements, as part of the eligibility criteria for fiscal benefits or subsidized credit. These policy instruments would not only stimulate formalization among SMEs, but also enhance their credibility and financial resilience, contributing to broader goals of inclusive and sustainable economic development.

For educators and training institutions, the findings suggest the need to include basic governance and financial literacy modules in SME-oriented programmes. Formulators of public policy should consider tailoring technical assistance and capacity-building initiatives, particularly in regions where informal management practices prevail, through partnerships with organizations such as SEBRAE. Supply chain leaders could incentivize governance adoption among SME partners by offering preferential financing or contracting terms to firms that demonstrate financial transparency and reliable management practices.

Future research should aim for a larger sample, use exact scores instead of ranges, and extend over more than one year. A longitudinal study could help to assess governance adoption and its evolution over time, offering a better framework for evaluating governance effectiveness in small businesses.