Non-Financial Stakeholder Relationship Costs as a Determinant of Capital Structure : Empirical Evidence from First-Time Business Start-Ups

Titman (1984) is the first to argue that non-financial stakeholders (customers, suppliers and employees) pass on their expected liquidation costs to the firm. In his framework, firms can influence the probability of liquidation by choosing an appropriate capital structure. Other studies have reasoned that the bargaining power of non-financial stakeholders (NFS) may also impact on financing decisions. This paper investigates these ideas in a sample of first-time business startups, where ex-ante failure risk is high and NFS have to make relationship-specific investments. We find that the size of NFS liquidation costs significantly reduces leverage and the proportion of bank loans. These effects are strengthened when customers have strong bargaining power. Finally, start-ups reduce their reliance on bank loans when suppliers and employees are in a powerful bargaining position