Optimal capital structure, model uncertainty, and European SMEs

We revisit the determinants of capital structure for European SMEs. Our work differs from previous contributions in the field by considering several measures of leverage (short-term debt, long-term debt, and total debt) and employing panel Bayesian model averaging, in an effort to address regression model uncertainty. Examining a rich set of firm-specific, country-specific, and institutional determinants of capital structure in 15 European Union countries over the period 2002–2019, we find that the effects of the different variables considered on leverage are intricate. First, only certain variables are important in explaining capital structure, based on their high posterior inclusion probabilities (above 0.5). Second, the effect of some variables differs depending on the measure of leverage considered. Under Bayesian model averaging, results are based on all possible models, rather than a particular one, and give a much greater depth of information. Therefore, our methods help to provide some additional guidance on the existing competing theories (trade-off, pecking-order, agency), which seems appropriate as empirical studies to date have not been conclusive. Our findings are especially pertinent in the European context where the predominance of SMEs, which are vulnerable to economic downturns, makes it particularly relevant to understand what determines their capital structure.