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«Volume Title: Conference on Research in Business Finance Volume Author/Editor: Universities-National Bureau Volume Publisher: NBER Volume ISBN: ...»

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An empirical basis for generalizations about factors influencing choices of forms of financing is provided by studies of financial structure. The most extensive source of basic data for such studies is contained in Statistics of Income and the Statistics of American Listed Corporations. Reports appearing in the Federal Reserve Bulletin also contain materials bearing on influences causing variations in form.s of financing.8 The. most analytical and suggestive study in this area is Chudson's monograph on The Pattern of Corporate Financial Structure.9 With respect to the influence of size, Chudson found that the ratios to total assets of all of the major current liability components decrease as the size of corporation increases. The ratio of long-term debt to total assets maintains no regular relationship to size. The ratio of net worth to total assets increases with size, but that of capital stock alone to total assets falls with size. Profitable corporations have lower debt-to-total-assets ratios, and higher net-worth-to-total-assets ratios compared with unprofitable corporations. Asset composition appears to have a considerable influence upon the structure of claims on assets. "An industry that requires relatively large current assets tends to rely to a greater extent on short-term financing than an industry requiring small current assets."° Chudson also 8A. R. Koch and C. H. Schmidt, "Financial Position of Manufacturing and Trade in Relation to Size and Profitability, 1946," Federal Reserve Bulletin, September 1947;

C. H. Schmidt, "Industrial Differences in Large Corporation Financing," Federal Reserve Bulletin, June 1948.

Walter A. Chudson, The Pattern of Corporate Financial Structure: A CrossSection View of Manufacturing, Mining, Trade, and Construction, 1937 (National Bureau of Economic Research, 1945).

ibid., p. 70.


calls attention to "evidence of the existence of a relationship between longterm debt and fixed capital assets."1' These are significant findings. Their importance in developing a framework for the analysis of entrepreneurial decisions in the choice of forms of financing is indicated in the following section of this paper.

In addition to the relationships described in the preceding paragraph, Chudson calls attention to the lack of close.parallelism between variations of the notes-payable-to-sales ratio and the (hypothetically related) current assets, and he observes that "the volume of short-term borrowings is subject to the somewhat arbitrary decisions of the firms making up the size groups in each industry."2 He suggests "that notes and accounts payable are more complementary than competitive, both in their employment by, and in their availability to, corporations."la Finally, Chudson examines the relationships between short-term debt and long-term debt, and between major categories of the long-term capital

structure. His conclusions are stated in these words:

Do long-term debt and short-term debt act as substitutes for each other among the various minor industrial divisions? An analysis of the rank correlations of the ratios of long-term and short-term debt to total assets indicates no statistically significant relationship, inverse or direct. The same absence of a substitute relationship, on an industrial basis, is found to characterize long-term debt and capital stock.'4 Assuming that Chudson's correlation technique has been correctly applied, his observations appear to have far-reaching implications. They suggest an absence of substitutability between the two large components of short-term debt, between short-term debt and long-term debt, and between long-term debt and capital stock.'5 One possible inference from these conclusions is that the scope for the exercise of managerial discretion in choosing between the major categories of financing forms is limited, because a broad and pervasive set of exogenous factors circumscribes the range of managerial These are interesting hypotheses. As Chudson has acknowledged, they require further testing by examination of frequency distributions of the components of financial structure of individual firms within specific industries. Further, the extent of substitutability between the subcategories of forms of financing, and between alternative types of suppliers of funds "ibid., p. 103. '2ibid., p. 54. '4lbid., p. 103.

p. 79.

15The relationships between short-term debt and capitalstock and between capital stock plus surplus and the major debt categories are not explicitly dealt with by Chudson.

p. 326 f. for a comment by Dr. Irwin Friend, who suggests other possible '° See inferences.


needs further investigation. Cross-section studies represent analyses of the statics of business financing. For many purposes, the relevant questions about financial decisions require longitudinal study of the dynamics of business financing, i.e., the considerations which determine the form of financing to be utilized when a particular type of asset is to be increased or some obligation requires refunding (this is also pointed out by Chudson). Some important elements of the financial decision-making process may be revealed only by analysis of individual cases. Aggregative studies of financial structure may suggest avenues of investigation, but they are not designed to yield definitive knowledge about factors influencing managerial choices of forms of financing.

4 Aggregative Studies of Financial Behavior through Time A number of analytical studies of the financial behavior of particular groups of business enterprises over selected time periods have been published.'7 Like the cross-section studies of financial structure at given points of time, these analyses yield valuable quantitative information about the sources and uses of funds by enterprises, and thus throw light on factors influencing managerial decisions.

Some of the most important findings of these studies may be summarized here. As might be expected, the size of the ratio of current liabilities to total assets is found to be positively associated with the size of the ratio of current assets to total assets. Similarly, temporal changes in current debt are found to be related to changes in current The influence of size of business upon the term of outstanding indebtedness, mentioned in cross-section studies of financial structure, is 'also corroborated.

Large firms offer sufficient stability to attract long-term commitments of funds by suppliers.19 Small firms typically have relatively low ratios of long-term debt to total assets, even in industries where the ratio of fixed assets to total assets is comparatively high.2° Thus, the simple generalizaLeading studies of this type include: A. R. Koch, The Financing 0/Large Corporations, 1920-1939 (National Bureau of Economic Research, 1943); C. L. Merwin, Financing Small Corporations in Five Manufacturing Industries, 1926-36 (National Bureau of Economic Research, 1943); Survey of Current Business: "Financial Performance of Large Corporations," August 1945; "Financial Trends of Large Manufacturing Corporations: 1936-46," November 1947; "Business Financing in the Postwar Period," March 1948; "Financing Corporate Capital Needs," November 1948; and the series of articles on financing new firms, December 1948, April 1949, April 1950, and June 1950.

Koch, op. cit., pp. 62-63.

'9lbid., pp. 5, 67.

20Merwin, op. cit., pp. 11, 59-60;


tion that asset composition governs the liability structure clearly must be modified to admit the influence of business size and other elements determining the risk position of the firm.

During the period covered by Koch's study (1920-39), large businesses decreased their use of both bank credit and trade credit as sources of funds.21 On the other hand, during the period spanned by Merwin's study (1926-36) small manufacturing enterprises tended to substitute trade qredit for bank credit.22 This latter finding appears to require a modification of the conclusion reached by studies of financial structure — that in the judgments of business management trade credit and bank credit are complementary rather than substitutable sources of funds.

Aggregative studies of business financing through time demonstrate the persistent importance of internal sources of funds, although they do not prove the existence of a secular increase in the relative importance of internal funds in financing business expansion.23 The reasons why internal financing holds such a high position on the managerial scale of preferences, and the implications of this fact for stability and growth of the economy, require further study.

Another aspect of the analysis of financial behavior through time is represented by c hanges in the relative importance of different sources of funds at different stages in the life cycle of firms. The Department of Commerce studies of the financing of new firms represent a valuable contribution,to our knowledge of sources of funds for businesses at their inception.

The findings to date indicate that equity capital supplied from past savings of the organizers of the firms is the predominant source of financing, and that bank and trade credit were also significant as contributing sources.24 A finding of importance in the financing of small corporations through time appears to be that managerial discretion in choosing between forms and sources of funds is closely constrained by the boundaries of available alternatives. Managers of large enterprises are conceded to have a greater range of choices, yet even for the large firm the scope of managerial discretion is not unlimited, since, according to Koch, "the specific sources of funds utilized may or may not be a matter of choice."25 The question then arises, to what extent the narrower range of choices open to the management of the small firm is inherent in its more exposed risk position, and to Koch, op. cit., pp. 80-8 1.

Merwin, op. cit., pp. 66-75.

Koch, op. cit., pp. 80-81.

See the statistics summarized by Lawrence Bridge in the paper, "The Financing of Investment by New Firms," in this volume.

Koch, op. cit., p. 61.


what extent it is a matter of custom, tradition, and financial standards governing the actions of suppliers of funds. Merwin appears to accept the former explanation, for he expresses skepticism of the need for providing small enterprises with additional types and sources of financing.20 The widely differing opinions held on this point suggest the desirability of more intensive study.

Studies of Types of Financial Contracts and Their Uses Another body of literature bearing upon the issue of managerial preferences is that concerned with various types of financial contracts and financing arrangements made available by different institutional and noninstitutional suppliers of funds. Suppliers of business funds, like suppliers of other commodities and services, engage in product differentiation and development activities, in order to penetrate and stimulate new markets for their services, adapting them to changes in the volume and pattern of demand for funds. This has been a continuing process over the years, but there is some evidence that it has been accelerated during the past fifteen years or so.

The proliferation of variations in bond and preferred stock contracts has obscured the boundary lines that have traditionally existed between these types of instruments and common stock. Changes in marketing techniques and arrangements have occurred, such as direct placement of securities by issuers in the portfolios of large institutional investors. Significant developments in extending medium- and long2term funds are represented by the growth of "term loans"; and, in the field of medium- and short-term credit, by lending on accounts receivable, lending on field warehouse receipts, and installment loans made on the security of commercial and industrial equipment. The "sale and lease-back" arrangement has come into prominence.

Standard textbooks in business finance usually devote a major part of their space to descriptions of the traditional contracts and instruments of financing. During recent years, studies conducted under the Financial Research Program of the National Bureau of Economic Research have dealt with some of the newer credit arrangements, defined their uses, and defined more precisely the nature of banking relations with business.27 Merwin, op. cit., pp. 65,89.

27Among studies published by the National Bureau of Economic Research are those by R. J. Saulnier and Neil H. Jacoby: Term Lending to Business (1942), Accounts Receivable Financing (1943), Financing Inventory on Field Warehouse Receipts (1944), Financing Equipment for Commercial and Industrial Enterprise (1944), and Business Finance and Banking (1947). No definitive study of "sale and lease-back" arrangements has been published to date.


Changes in the array of financial contracts available to business hold significance for the present inquiry in two respects. In the first place, these developments have widened the range of alternatives and thus extended the scope of managerial discretion, especially for medium and small enterprises. In. the second place, the nature of the changes in forms of financing made available by suppliers constitute indirect evidence of the nature of factors influencing the choices of business managers. The new credit techniques, as is pointed out by Saulnier and Jacoby, have been fashioned to meet the special characteristics of the production and merchandising processes of businesses.

Some of the features of these newer types of loans for which a strong demand has existed during recent years are these: 1) continuity in the availability of credit to the user; 2) flexibility in the amount of credit purchased in accordance with the borrower's requirements; 3) provision of ancillary services such as credit-rating and collection of accounts; 4) gearing the loan amortization schedule to the ability of the business to "throwoff" cash frOm operations, and 5) reductions in the cost of acquiring and using credit.

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