SME rebalancing short-term and long-term debt ratios: the role of financial distress costs

Purpose This study seeks to analyze the effect of the financial distress costs on small and medium-sized enterprises (SME) rebalancing of short-term and long-term debt ratios. Design/methodology/approach The authors use the system-generalized method of moments (GMM-sys) to treat data collected for a sample of Portuguese manufacturing SMEs for the period 2011–2017. Findings Financial distress costs positively impact the speed with which SMEs rebalance their short-term and long-term debt ratios The positive effect of financial distress costs on the speed of adjustment (SOA) is higher for the short-term than for the long-term debt ratio. This result suggests that SMEs seek to overcome quicker the financing imbalance in the short run, probably, due to their dependence on short-term debt. Practical implications SME owners-managers should seek to rely less on short-term debt to reduce the firm default risk, the financing imbalance and the financial distress costs. Banks should lend long-term loans to SMEs, given that the high financial distress risk of these firms results from their dependence on short-term debt financing. Policymakers should promote SME access to external finance sources with lower transaction costs, to SME rebalance their capital structures. Originality/value This study analyzes the effect of financial distress costs on the SOA with which SMEs rebalance their capital structure. We estimate the financial distress costs based on a hazard model, to analyze their effect on the SOA toward the target debt ratios.