ERC3 - Project 1. Investing for the Future - Finance, strategy and investment in SMEs. June 2018

1. Investing for the Future?
Finance, strategy and investment in SMEs
Mark Hart, Stuart Fraser and Victor
Ekpu

2. Financial constraints and missing links
• Research from ERC2, with LSBS data, indicates that the firm’s financial
status in one year (2015) has a significant effect on its performance in the
following year (2016).
• Relative to successful seekers (SS) of finance in 2015, who achieved a
productivity of £163,000 sales per worker on average in 2016, other things
equal:
– The productivity of happy non seekers (HNS) was £123,000.
– The productivity of discouraged borrowers (DB) was £154,000.
– The productivity of failed seekers (FS) (who were rejected by finance
providers) was £140,000.
• This lower performance due to financial status is consistent with:
– Financial constraints among DB and FS who have unmet external capital
needs.
– ‘Control aversion’ among HNS who, whilst not having external capital needs,
seem to ‘prefer’ lower performance to using external finance.

3. Financial constraints and missing links
• Analysis sheds light (for the first time) on various strategic and
operational mechanisms linking financial constraints/undercapitalisation
to subsequent firm performance
• Specifically, this analysis looks at the impact of financial status on
– The implementation of business strategies (a mediating mechanism).
– The performance benefits derived from existing business capabilities (a
moderating mechanism).
• The main mechanism accounting for lower productivity among HNS is that
they have a lower likelihood of implementing business strategies (relative
to SS).
• The main mechanism accounting for lower productivity among DB and FS
is that they derive lower performance benefits from their existing
business capabilities
– So whilst DB and FS push ahead with business strategies their capabilities in
implementing these strategies are compromised by financial constraints.

4. Relationships between financial status,
business strategies, capabilities, and
performance
Financial Status:
Happy non seeker
Discouraged borrower
Failed seeker
Successful seeker
Business
Strategies:
Human resource
Innovation
Small Firm
Performance:
Productivity
Business Capabilities:
Strategy implementation
Operational improvement

5. Research Questions
These questions extend and develop the previous project and extend this to
consider impacts of financial constraints on intangible investments:
RQ1: Examining further mechanisms linking financial status to firm performance
(e.g., via investment in tangible and intangible assets).
RQ2: Estimating the quantitative impacts of unmet external capital needs
(“funding gaps”) on firm performance (to go beyond the qualitative impacts of
financial status). What is the impact of a £1 increase in funding gaps on firm
performance?
RQ3: Understanding the longer term impacts of financial status/funding gaps on
firm performance.
RQ4: How do financial constraints impact on SMEs’ willingness to invest in
intangibles and innovation?

6. Data
RQ1: Examining further mechanisms
linking financial status to firm
performance
RQ2: Estimating the quantitative impacts
of unmet external capital needs (“funding
gaps”) on firm performance.
RQ3: Understanding the longer term
impacts of financial status/funding gaps
on firm performance.
Current analysis is based on LSBS waves 1
and 2. Additional data from LSBS Wave 3
is now available and provides insight into
the longer term effects of finance
constraints
RQ4: How do financial constraints impact
on SMEs’ willingness to invest in
intangibles and innovation?
UK Innovation Survey provides data on
firms’ investment in intangibles as part of
their innovation activity as well as data on
financial constraints. This covers design,
R&D etc as well as training and capital
investment and computer software for
innovation.

7. Project plan
RQ1: Examining further mechanisms
linking financial status to firm
performance
RQ2: Estimating the quantitative impacts
of unmet external capital needs (“funding
gaps”) on firm performance.
RQ3: Understanding the longer term
impacts of financial status/funding gaps
on firm performance.
ERC research paper 1 - November 2018
RQ4: How do financial constraints impact
on SMEs’ willingness to invest in
intangibles and innovation?
ERC Research paper 2 – Jan/Feb 2019