Life Duration and Debt Structure of Financially Distressed SMEs

Author Name XU Peng  (Faculty Fellow, RIETI / Professor, Faculty of Economics, Hosei University) /TSURUTA Daisuke  (National Graduate Institute for Policy Studies / CRD)
Creation Date/NO. February 2006 06-J-009
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Using the extensive microdata of the Credit Risk Database (CRD), established in 2001 by the Small and Medium Enterprise Agency of the Ministry of Economy, Trade and Industry (METI), in this paper we analyze the determinants for the life duration until legal bankruptcy of small and medium-size enterprises (SMEs) that have continually been saddled with excess liabilities and suffered recurring losses. We focus in particular on the debt structure of SMEs, clarifying the impact of the ratios and trends of trade credit and bank financing on the timing of legal bankruptcy. The results of this paper's analysis are set out below.

First, the ratio of trade payables to total liabilities increases the probability of financially distressed SMEs' falling into legal bankruptcy. There is also a tendency for the ratio of trade credit to decline substantially several years prior to legal bankruptcy. In addition, the larger the degree of decline in trade credit, the shorter is the survival duration of a firm from the time of suffering financial distress to the time of legal bankruptcy. However, the ratio or trend of bank financing does not affect the survival duration. These findings conform to the following characteristics of trade credit. First, trade credit in the form of unsecured claims gives rise to a greater loss if the debtor firm goes bankrupt, and therefore suppliers granting such credit have the incentive to acquire advance corporate credit information more rapidly than banks that are secured creditors. Second, since suppliers have networks with other enterprises, it is possible to obtain credit information on debtor SMEs at a lower cost and more quickly than banks. Third, generally a firm does business with a large number of other suppliers and it is difficult for suppliers to conduct private negotiations among them on such matters as balance maintenance and debt forgiveness. In addition to debt structure, the better a company's corporate fundamentals, for example total asset turnover and ordinary income ratio, the longer will be the duration of its life. Profitability has a stronger effect on medium-sized enterprises than on smaller firms. In addition, SMEs with high fixed-asset ratios and substantial liquidity in hand have a high survival probability and their survival duration is long. On the other hand, SMEs that are relatively large in scale, those with high ratios of interest-bearing liabilities and those with a high proportion of trade credit accounted for by bills payable have low survival probability and a short survival duration. Finally, the paper confirms that financially distressed SMEs that have been relieved by the government support measures for reviving SMEs, such as credit guarantees and the special credit guarantee program for small businesses, have a high probability of survival in the short term, and have long life duration.