Debt financing and firm performance: an empirical study based on Swedish data

TLDR

SMEs play a key role in the economy, yet the effect of debt on their performance has rarely been examined with advanced econometric methods such as 3SLS and fixed‑effects models. The study examines how debt levels affect performance among Swedish SMEs. Using a cross‑sectoral sample of 15,897 Swedish SMEs from 2009‑2012, the authors applied three‑stage least squares and fixed‑effects models to analyze debt‑performance relationships. The analysis shows that higher trade credit, short‑term, and long‑term debt ratios negatively impact profitability, increase agency costs, and prompt SME owners to rely more on equity financing, underscoring debt policy’s importance for firm value and survival.

Abstract

Purpose – The purpose of this study is to examine the relationship between debt level and performance among small and medium-sized enterprises (SMEs). Design/methodology/approach – Unlike the vast majority of previous research, this study uses three-stage least squares (3SLS) and fixed-effects models to analyse a comprehensive, cross-sectoral sample of 15,897 Swedish SMEs operating in five industry sectors during the 2009-2012 period. Findings – This study confirms that debt ratios, in terms of trade credit, short-term debt and long-term debt, negatively affect firm performance in terms of profitability. As a high debt ratio seems to increase the agency costs and the risk of losing control of the firm, SME owners and managers tend to finance their businesses with equity capital to a fairly high degree. Practical implications – As debt policy significantly influences firm performance, and thereby firm value and survival, SME owners and managers should focus on finding a satisfactory debt level. Originality/value – To the authors’ best knowledge, this study is among the first to use 3SLS and fixed-effects models to analyse the relationship between debt level and firm performance. Moreover, while most previous research has examined listed firms, this study highlights the issue among SMEs, which play a fundamental role in the economy.