Capital Structure Decisions During a Firm's Life Cycle

The study reported here examines the financing choices of small and medium-sized firms, i.e., those most vulnerable to information and incentive problems, through the lens of the business life cycle. We argue that the controversy in the empirical literature regarding the determinants of capital structure decisions is based on a failure to take into account the different degrees of information opacity, and, consequently, firms' characteristics and needs at specific stages of their life cycles. The results show that, in a bank-oriented country, firms tend to adopt specific financing strategies and a different hierarchy of financial decision-making as they progress through the phases of their business life cycle. Contrary to conventional wisdom, debt is shown to be fundamental to business activities in the early stages, representing the first choice. By contrast, in the maturity stage, firms re-balance their capital structure, gradually substituting debt for internal capital, and for firms that have consolidated their business, the pecking-order theory shows a high degree of application. This financial life-cycle pattern seems to be homogeneous for different industries and consistent over time.