'Relationship' in Small Firm Finance: A Study of Small Enterprises in West Bengal

Abstract

The small and medium enterprise (SME) sector provides an impetus to economic development; yet, their operations and growth are often constrained by their limited ability in obtaining credit. Financial intermediation theory demonstrates that asymmetric Information plays an Important role In debt contract negotiations between the bank and the firm. Small firms are further vulnerable because of their sole dependence on financial Institutions/banks for external funding. These firms do not have access to public capital markets. Under the given situation, a good relationship of the entrepreneur with the lenders could be a source of soft information about the firm that would help mitigate the Information problems in small firm finance.

In order to crystallize this research Issue, this paper has used data collected from 100 small firms, selected from two districts of West Bengal, having filed EM II with the Die, Government of India as per the MSMED Act 2006, during the five year period 201O-2014.

The final results reveal a statistically significant positive relation between financial leverage of the sampled firms and the quality of their relationship with the lenders (measured by a score on a specially constructed Relationship Index). Therefore, we may Infer that small firms incapable (or reluctant) of disclosing information (hard Information) to the debt providers will have an incentive to build a relationship with their lenders in order to minimize the financial problem.