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Internationalization and Financing Options of SMEs in Ghana
The importance of small and medium scale enterprises (SMEs) to stimulate the growth of the any economy cannot be under estimated. However, the capacity of SMEs to generate growth is hindered by a number of constraints notable among them being the lack of access to affordable long term credit. The problem of financing Ghanaian SMEs especially those in the non-traditional export (NTE) sector has been of great concern for some time now. This pre-occupation is mainly a result of the role the SMEs in the NTE sector are supposed to play in the development of the economy. This paper presents a study of internationalization and the financing options of small and medium scale non-traditional exporters in Ghana. The study also examines how age and size of the firm affect the choice of financing. Descriptive statistics were employed in the presentation and analysis of results. The results show a positive association between debt financing and age of the firm. With time, firms become more acceptable to lenders and therefore older firms are more likely to obtain debt financing than younger firms. With respect to size, the results show that, larger firms are more likely to receive debt financing than smaller firms. The results show a negative relationship between degree of internationalization and debt financing. This suggests that, as firms engage more in international activities, they employ less debt but use more of equity financing. This is explained by the fact that, firms involved in international business may not want to expose themselves to more risk by increasing financial risk which is associated with debt financing. The results generally support existing theory.
Keywords: internationalization, financing, capital structure, SMEs, NTEs, Ghana
The problem of financing Ghanaian small and medium scale enterprises (SMEs) especially those in the non-traditional export (NTE) sector has been of great concern for some time now. This pre-occupation is mainly a result of the role the SMEs in the NTE sector are supposed to play in the development of the economy. Not only are they important for the vitality of the business sector, they also contribute to job creation (Lader, 1996).
Previous studies have offered various conjecture regarding the determinants of financial leverage of firms, such as asset structure, firm size, profitability, risk, and growth (Titman and Wessels, 1998; Wald, 1999; Harris and Raviv, 1991; Myers, 1984; Petersen and Rajan, 1994, Bradley et al., 1984). Few empirical studies have validated the theoretical capital structure from an international perspective, and those that have, only focused on the evaluation of the internationalization effect on identified capital structure determinants to address the difference between large multinational corporations (MNCs) and domestic companies (DCs) (Shapiro, 1978; Michel and Shaked, 1986; Fatemi, 1988; Lee and Kwork, 1988). Other researches have focused on the direct effect of international factors, such as political risk, foreign exchange risk, and tax benefits, on the financing policy of MNCs (Lee and Kwork; 1988 and Burgman, 1996).
However, the issue of financing options for SMEs in the internationalization process has received limited attention. Zingales (2000) asserts that, “empirically, the emphasis on large companies has led us to ignore (or study less than necessary) the rest of the universe: the young and small firms, who do not have access to public markets”.
The present study aims at determining the effect of the level of internationalization on the financing decisions of SMEs NTEs in Ghana. This paper specifically focuses on the capital structure of small and medium sized exporters drawn from the Ghana Export Promotion Council’s (GEPC) database of NTEs in Ghana. To achieve this objective, the paper also sought to incorporate some firm level characteristics such as age and firm size effects, two related variables that have been associated with capital structure of SMEs. A sample of NTEs in the Greater Accra region is used for the purposes of this study. The structure of the remainder of the paper is as follows. Section 2 gives a review of existing literature on internationalization of firms and the capital structure theories of SMEs. Section 3 explains the methodology employed for the study. The empirical results are presented and discussed in section 4. Finally, section 5 summarizes and concludes the discussion.
2.0 Literature Review
This section provides a review of the theoretical literature on and internationalization and financing of firms. It begins with the theoretical framework of internationalization of firms. It then discusses the theoretical literature on capital structure.
2.1 Internationalization of Firms
Internationalization of a firm from the theoretical stand point usually tries to give answers to questions about why, when, where, and how firms engage themselves in international trade? Despite, the widespread agreement regarding the growing global integration of economies activities there is not a general agreement on the definition of internationalization. Wind et al (1973) define this notion as a process in which specific attitudes or orientations are associated with successive stages in the evolution of international operations. Johanson and Valne (1977) conceive internationalization as a sequential process of increased international involvement, whilst Welch and Luostarinen (1988) interpret internationalization as the process of increasing involvement in international operations. In a much broader conceptualization, Calof and Beamish (1995) interpret internationalization as the process of adopting firm's operations to international environments.
The growing integration of national and regional economies in a global network of production and distribution coincided with an increased academic interest in theory development regarding the internationalization of the firm, leading to the development of a number of new approaches during the post-1970 period. These approaches have been reviewed comprehensively by O'Farrell et al (1996), and Andersen (1997).
One of the earliest approaches, the Upsalla model, suggests that internationalization activities increase incrementally (Johanson and Wiedersheim-Paul, 1975; Johanson and Valne, 1977). This process is influenced by increased market knowledge, which leads to increased commitment to international markets and vice versa. According to this model the firm follows four stages in the internationalization process:
· no regular export;
· export via independent enterprises or agents;
· sales subsidiaries;
· establishment of production plants overseas.
Kuada and SØrensen (2002), maintain that, the existing stages model can be divided into two types:
1. Models showing internationalization to be based on learning and the accumulated experience – the Learning Stages Theory
2. Models showing internationalization to be based on adaption to changes in the environment – the International Product Life Cycle Theory
According to the Learning Stages theory, the internationalization of a company is an orderly and sequential process in which the shift from one stages to the next is base on learning and accumulation of experience within the preceding stage. In the International Product Life Cycle Theory, a company’s internationalization can be divided into three stages, namely: new product, maturity product and standardized product.
Another approach draws upon the insights gained by Transaction Cost Analysis (TCA). Transaction costs include the expenses associated with the acquisition of information regarding relevant prices, and the costs entailed in the negotiation and enforcement of contracts. Asset specificity, the frequency of economic exchange, and the level of uncertainty are the key influences in determining the cost of transacting. Within this context, the decision-maker is boundedly rational and aspires to minimize the cost of transacting associated with entry into the international marketplace. The network approach bear considerable similarities with TCA: it draws on theories of social exchange and resource dependency, and focuses on firm behaviour within interorganizational and interpersonal relationships. Thus, the boundaries of the firm are determined not only by formal relationships but also by informal, personalized linkages (Coviello and McAuley, 1999). The eclectic framework developed by Dunning (1981) embraces elements of earlier approaches. It suggests that the level and structure of a firm's international activities will depend on the configuration of particular ownership (firm specific assets and skills), location (country specific market potential, investment risk, production costs and infrastructure), and internalization advantages (the cost of transacting), as well as the extent that the firm believes that investment in a particular country is consistent with its long-term management and strategy. Lastly, the Organizational Capability approach conceptualizes the firm as a bundle of relatively static and transferable resources, which are then transformed into capabilities through dynamic and interactive firm-specific processes (Amit and Shoemaker, 1993).
There is considerable disparity in the ability to exploit opportunities, and confront threats emanating from the internationalization of economic activity by sizeband. Thus, whereas large firms and particularly multi-national corporations (hereafter MNCs) have had a considerable experience of involvement in global markets, the majority of SMEs have only recently adopted an international perspective in their strategies (Bijmolt and Zwart, 1994; Tesar and Moini, 1998). More specifically, a growing number of publications drawing upon the experience of SMEs in advanced industrialized countries suggests that these firms are confronted with greater difficulties in accessing international markets than their large-scale counterparts (Van Horn, 1979; Roth, 1992; Stokes, 1992; Smallbone and Wyer, 1995). The inability to control prices because of lack of market power, a dependency upon a relatively smaller customer base, and limited - if any access to policy-makers make the external environment of a small firm more uncertain than in a large business.
An altogether different set of constraints emanates from the limited resource base of SMEs. Specifically, the financial resources available to a small business can act as a considerable constraint in developing an international orientation. This can take two forms: lack of finance may impede the firm's ability to identify opportunities arising from the opening-up of national markets; whilst inadequate financial resources may restrict the exploitation of opportunities already identified (Smallbone and Wyer; 1995).
2.2 Capital Structure and Financing of SMEs
A decision to start a business or expand an existing firm by increasing the productive assets, involves an implicit decision to raise money capital in order to finance the growth. There are three main sources of funds; namely equity financing, debt financing, and the use of retained earnings. The first two sources, equity and debt financing constitute external financing, while retained earnings are an internal source (Koutsoyiannis, 1982).
The capital structure of a firm concerns the mix of different securities. Brealey and Myers (2003) contend that, the choice of capital structure is fundamentally a marketing problem. They state that, the firm can issue dozens of distinct securities in countless combinations but it attempts to find the particular combination that maximizes market value. According to Weston and Brigham (1990), the optimal capital structure is the one that maximizes the price of the firm’s stock. The theoretical literature for explaining the capital structure of large firms also applies in the case of SMEs. The finance literature provides three major theories of capital structure: (i) the agency cost/tax shield trade-off model, (ii) the pecking order hypothesis; and (iii) the signaling model. Megginson (1997) provides a review of these theories with an emphasis on the most researched - the trade-off model. In this model, firms choose their capital structures by trading off the tax benefits of debt with the agency costs of debt and expected bankruptcy costs.
Certain variables have been identified in literature to be associated with the financial structure of SMEs. For the purpose of this study, the paper provides a review of two of these variables that have been used in previous studies and also discusses capital structure and international activity. These are discussed in turn.
Age as a determinant of SMEs financing preference has received little attention. There is little in the literature on this factor. Leeth and Scott (1989) in their research included age as a measure of risk and reputation. Reputation formation takes time and it provides improved incentives to borrowers. In the absence of reputation, borrowers have incentives to select excessively risky projects.
Petersen and Schulman (1987) provided a general model relating the financial structure of small firm to its age. They suggest the ownership ratio is high for new firms. In agreement to this position, Petersen and Rajan (1994) assert that older firms have higher debt ratio since they are seen to be of high quality firms. Barton et al (1989) state that, it is expected that mature firms will experience lower earnings volatility and can be taken as agreeing that, in turn, it is expected that these firms will have higher debt ratios. Though, maturity is rather spoken of, rather than age, we can intuitively relate maturity to age in a direct fashion.
Wedig et al (1988), however concluded that age is negatively related to debt ratio. Diamond (1989) agrees with this position by stating that the longer the firm survives in business, the more internally generated profits it can accumulate and subsequently use it to replace debt financing. Thus its ownership ratio as in the ratio of shareholders funds to total assets will rather be high.
The framework used by Feeney and Riding (1997) and Brewer et al (1995) is adopted for the present study. They defined age in terms of (those less than one year), (between one and five years), (between five and ten years) and (over ten years).
2.2.2 Firm Size
There are several theoretical reasons why firm size would be related to capital structure of the firm. Firstly, smaller firms may find it relatively more costly to resolve information asymmetries with formal lenders and financiers. Consequently, smaller firms are offered less capital, or are offered capital at significantly higher costs than larger firms.
The transaction costs associated with financing may also affect financing choices as transaction costs are most likely a function of scale, with smaller scale financing resulting in relatively higher transaction costs (Timan and Wessels, 1988; Wald, 1999). A related issue is the marginal effects of market access for different sized firms (Scherr et al., 1993). This could be a function of high transaction costs effectively making some financing options outside the available set of financing choices of the firm. However, market access can also be constrained directly in that some financing options are not in the scale range that formal financiers would consider issuing finance. A simple example is the scale required to obtain equity funds publicly, thereby excluding smaller firms from this type of finance.
According to Titman and Wessels (1988), another explanation for smaller firms having lower debt ratio is if the relative bankruptcy costs are an inverse function of firm size. This view is also explained differently by Castanias (1983). He states that if the fixed portion of default costs tends to be large, then marginal default cost per dollar of debt may be lower and increase more slowly for larger firms. Facts about larger firms may be taken as evidence that these firms are less risky (Ferri and Jones, 1979; Kim and Sorensen, 1986) Cosh and Hughes (1994) add that if operational risk is inversely related to firm size, this should predispose smaller firms to use relatively less debt.
Empirical evidence on the relationship between size and capital structure of firms are quite varying with respect to conclusions. Several works support a positive relationship between firm size and leverage (Marsh, 1982; Friend and Lang 1988; Barclay and Smith 1996; Rajan and Zingales, 1995; Cassar and Holmes, 2003).
Gupta (1969) found negative relationship between size and debt ratio Fischer et al (1989), identified a negative relationship between size and debt ratio. They argued that this result is in accordance with the theoretical model of relevant capital structure choice.
Others have also found no relationship between size and leverage. Aggarwal (1981), Collins and Sekely (1983), Mehran (1992) and Roden and Lowell (1995) all maintain that there is no relationship between size and leverage. They therefore concluded that size should not be a determinant of financial leverage.
In this study, size is defined according to the Regional Project on Enterprise Development (RPED) classification. The classification of firms by size as given by the RPED Ghana manufacturing survey paper is given as follows:
Micro enterprise less than 5 employees
Small enterprise 6 - 29 employees
Medium enterprise 30 – 99 employees
Large enterprise 100 and more employees
(Teal et al, 1998)
2.2.3 Degree of Internationalization
Following from the reasoning of the trade-off model, it is posited that international diversification reduces the expected cost of bankruptcy and allows for increased debt capacity. Other researchers, however, suggested that internationalization can lead to higher agency costs and a lower level of debt (Lee and Kwok 1988).
Bradley et al (1984) suggest that firms with a higher operating risk should have lower debt, which means that the risk of the firm’s business or operating cash flows is considered to be a basic capital structure determinant in tradeoff models. Shapiro (1978) suggests that a firm’s international diversification is a factor that may be relevant in establishing worldwide capital structures. Fatemi (1988) and Lee and Kwork (1988) find that MNCs’ leverage is lower than DCs’ was. Burgman (1996) suggests that specific international factors such as political risk and exchange rate risk are relevant to the multinational capital structure decision.
Prior evidence indicates that MNCs utilize less debt in their capital structure relative to their DC. Agmon and Lessard (1977) suggest that equity capital is less costly with firm international activity. Reeb et al (1998) reach an opposite conclusion counterparts, which is attributed to greater exchange rate risks, political risks, and agency costs. The implication is a higher cost of debt financing for international firms. Lee and Kwok (1988) compare MNCs and DCs capital structures and find that MNCs have lower debt-to-equity ratios primarily as a result of greater agency costs. Similarly, Burgman (1996) reports that MNCs have a lower target debt-to-equity ratio than purely DCs. His findings suggest that target debt levels for MNCs are determined by a tradeoff between the tax advantage of debt and the agency costs of debt.
In addition, Chen at al (1997) examine the relation between international activities and capital structure, using a debt-to-equity ratio. Their approach explicitly examines whether there is a direct relation between firm internationalization and debt financing. They find that MNCs have a lower debt ratio than their DCs, and that within MNCs the level of international activity is positively associated with the debt ratio. They also find, consistent with prior research, that the debt ratio is negatively related to bankruptcy costs and growth options. Similar results for U.S. based MNCs are also reported in Kwok and Reeb . In aggregate, these studies suggest greater risk and agency costs with firm international activity and implies a higher cost of debt capital.
It is therefore postulated that, firm international activity may have different impacts on debtholders based on the level of these activities. This paper examines the impact of SMEs’ degree of internationalization on their (capital structure) financing options. The paper focuses on NTEs in Ghana because about 97% of NTEs fall within the category of SMEs (Buatsi, 2002). The degree of internationalization of SMEs can be explained in terms of the growth of export intensity or the foreign sales ratio (i.e. the ratio of export sales to total sales) (Hamilton and Fox, 1998).
A field research is adopted to investigate the effect of internationalization on the financing options of SMEs NTEs. The paper also incorporates age and firm size effects in the analysis. A sample of 100 NTEs within the Accra and Tema metropolis is considered. Out of the total of 100 questionnaires, 44 were received from respondents representing a response rate of 44%. Whilst this might not seem a high percentage, empirical studies involving SMEs have been known to generate for lesser percentage response rates.
3.2 Data Collection and Analysis
The research made use of both primary and secondary data. Secondary data was collected on the capital structure ratio of the firms from their most recent balance sheet. Capital structure is measured by using the debt ratio (i.e. total debt divided by total assets). Primary data was collected from questionnaire administration. This involved the conduct of interviews and/or interrogation; preparation of a number of questionnaires and their administration. The questionnaire included both structured and unstructured forms of questionnaire. The structured was used in order to present the respondent with a fixed set of choices whiles the unstructured sought to encourage respondents to share as much information as possible in an unconstrained manner. Data for the analysis was extracted from the field survey carried out by the researchers. Analysis is essentially descriptive; therefore, descriptive statistics are employed in the presentation and analysis of results.
4.0 Presentation of Results
This section is devoted to the presentation, analysis and discussion of the empirical results. The results indicate the frequency of debt and equity financing considering firm characteristics such as age, size and degree of internationalization.
Table 1: Age and Financing Choice
Table 1 shows how age affects the financing choice of the firms. Among firms less than one year old, 10% of financing were in the form of debt, while firms between one and five years reported debt ratio of 32.2%. The shares of debt of firms between six and ten years and those over ten years were 42.3% and 48.6% respectively. The results show that debt financing increases with age of the firm. The age effect seems consistent with previous studies (Petersen and Rajan, 1994; Barton et al, 1989). It is expected that, with time firms become more acceptable to lenders i.e. debt levels will rise causing ownership ratio to fall.
Table 2: Firm Size and Financing Choice
Table 2 reports the relationship between size and financing choice. There were no firms with employee size of less than five in the valid responses. Among firms with between five and twenty nine employees, 43.3% of financing was in the form of debt. Thirty five percent (35%) debt financing was reported for those with employees between thirty and ninety nine. Firms with over hundred employees also showed 57.7% debt financing. The findings provide support for theory (Castanias, 1983; Titman and Wessels, 1988; Wald, 1999). Larger firms are more likely to have access to more debt financing than smaller firms. Smaller firms, apart from being less diversified, find it relatively more costly to resolve information asymmetries with lenders, therefore, may present lower debt ratios.
Table 3: Degree of Internationalization
The effects of the degree of internationalization (measured by export intensity) on the firms’ financing options is shown in table 3. Firms with export intensity or foreign sales ratio of less than 26% reported 62.4% of debt and 37.6% of equity financing. Firms with foreign sales ratio of between 26% and 50% had debt ratio of 60.4%, while those with foreign sales ratio of between 51% and 75% and 76% - 100% had debt ratios of 53.3% and 52.9% respectively. The results indicate that, debt ratio declines with increasing international activities, suggesting that as firms engage more in international business, they employ less debt. This position is consistent with other findings (Bradley et al, 1984; Fatemi 1988; Lee and Kwork, 1988). Firms involved in international business are already exposed to high risk in the form of exchange rate risk and political risk and as such may not want to be exposed to additional risk (financial risk) by employing more debt. Thus, they will rely more on equity financing.
The problem of financing Ghanaian small and medium scale enterprises (SMEs) especially those in the non-traditional export (NTE) sector has been of great concern for some time now. This pre-occupation is mainly a result of the role the SMEs in the NTE sector are supposed to play in the development of the economy. The paper presents a study of internationalization and the financing options of NTEs in Ghana. The study examines how the firms’ degree of internalization affects the choice of financing. It also incorporates other firm level characteristics such as the age and size effects. The results show a positive association between the incidence of using debt and age of the firm. With time, firms become more acceptable to lenders and therefore, older firms are more likely to obtain debt financing than younger firms. This effect conforms to standard theories on capital structure choice. In addition, the study found that, larger firms are more likely to receive debt financing than smaller firms. This appears to support earlier studies. Finally, the study found a negative relationship between degree of internationalization and debt financing. The results suggest that as firms engage more in international activities, they employ less debt but use more of equity financing. This is explained by the fact that, firms involved in international business may not want to expose themselves more to risk by increasing financial risk which is associated with debt financing. The results generally support existing theory.
International Diversification’, The Journal of Finance 32:4, 1049-1055.
17. Collins, J. Markham, and William S. Sekely, (1983) The relationship of headquarters country and industry companies, The Journal of Finance (June),
 Lecturer in Finance, School of Administration, University of Ghana, email: firstname.lastname@example.org
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