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Is the Growth of Small Firms Constrained by Internal Finance?

The Review of Economics and Statistics · 2002 · 1.1K citations · 46 references

TL;DR

When financing constraints bind, an extra dollar of internal finance should raise assets by more than a dollar, a prediction that does not apply to the few firms accessing external equity. This paper examines the long‑standing theory that small‑firm growth is often limited by the amount of internal finance. The authors test this theory using a panel of more than 1,600 small firms. They find that most small firms’ growth is constrained by internal finance, a result that has implications for models of firm growth.

Abstract

This paper examines the long-standing theory that the growth of small firms is often constrained by the quantity of internal finance. Under plausible assumptions, when financing constraints are binding, an additional dollar of internal finance should generate slightly more than an additional dollar of growth in assets. This quantitative prediction should not hold for the relatively small number of firms which access external equity. We test these predictions with a panel of more than 1, 600 small firms and find that the growth of most firms is constrained by internal finance. Our results have implications for several different research literatures, including models of firm growth.