Capital structure and its choice in Central and Eastern Europe

We analyze the determinants of capital structure and its choice by small and medium-sized enterprises in Central and Eastern Europe from 2002 to 2007. We test the relevance of the three main theories: the Static Trade-off Theory, the Pecking Order Theory, and the Agency Theory, which have been derived primarily for developed markets, because our knowledge on their validity for emerging European countries is limited. We confirm the positive impact of size and asset tangibility on the leverage, while rejecting both the positive impact of profitability and tax, as well as the negative impact of business risk and non-debt tax shields. We report that SMEs behave homogeneously, and the relevant capital structure determinants show remarkable steadiness. Our results show a special time varying behaviour, in which the relevant determinants become stronger, while most of the country-specific factors present weakening effects. We argue that firms of the CEE countries remarkably converged their financial decision-making procedure to that of developed countries through the investigated period. The relevance of the Trade-off Theory is weak, as firms respect a one-sided upper threshold rather than converging to a fixed target on both sides, while they are not indifferent to the hierarchy of financing alternatives.