HAFIZAH MAT NAWI (Registration Number: 0734133)

ANNUAL REVIEW (2010)

Research Title:
The Financing of Small and Medium Enterprises (SMEs): A Comparative Study of
SMEs Business Owners in Malaysia Based On Three Ethnic Groups
---------------------------------------------------------------------------------------------------------------Abstract
This research investigates the influence of generic factors and cultural factor on financing
decisions of Malaysian SMEs owners-managers. In doing this, four main determinants of
capital structure; namely SMEs characteristics, owner-manager characteristics, businesslender relationship and cultural factor are elaborated. The paper also looks at how the
financing decisions of SMEs businesses can affect the organizations performance.
Additionally, the study identifies the financing patterns of three ethnic groups, namely Malay,
Chinese, and Indian. This research also looks at the way the government, economic
conditions, and social pressure indirectly influence the financing decisions of SMEs. The
study addresses the following primary question: What are the factors which influence the
financing decisions of three different ethnic groups in Malaysias SMEs? The samples of this
research are the SMEs in the East-Coast region of Malaysia. A pre-pilot test of five SMEs had
been conducted in the U.K in order to test the level of understanding of the questions among
business owners. Further, 25 interviews (10 individual interviews, 2 focus groups) had been
conducted in Malaysia in May 2010 for items confirmation. 30 pilot studies had also been
carried out in Malaysia between 20th May 2010 and 25th June 2010. The primary data
collection is acquired through survey questionnaires which were carried out from 15th July
2010 to the early of September 2010; and it will be analyzed by using SPSS 15.0.
Introduction and Rationale of the Present Research
Research into small, medium-sized enterprises (SMEs) and entrepreneurship has grown
during the last decade. Majority of firms worldwide are SMEs, and they play a significant
role in the economy. The performance of the SME sector therefore, is closely associated with
the performance of the nation. In Malaysia, for instance, SMEs which are defined as firms
with annual sales turnover not exceeding RM25 million or full-time employees not exceeding
150 (SME Annual Report, 2007), represent 99% of total business establishments;
contributing up to 32% of GDP and 56% of total employment (SME Annual Report, 2007).

HAFIZAH MAT NAWI (Registration Number: 0734133)

ANNUAL REVIEW (2010)

This research is pertinent with the introduction of the 1ECER and equality issue (One
Malaysia), both definitely affecting Malaysian SMEs which are the main national providers
of employment as well as products and services.
The question whether a finance gap exists in small and medium-sized businesses has been
examined and analysed over many years. Although a lot of initiatives have been done by the
government and financial institutions in order to bridge the gap, many argue that the gap still
exists, particularly for firms starting-up or in the growing stage. The finance gap refers to a
situation where a firm has profitable opportunities but there are insufficient funds to exploit
the opportunity (Carter and Evans, 2000, p.339). In order to overcome the problem of
insufficient funds, the right financing decision is needed. This study therefore focuses on
capital structure decisions which are crucial for the financial well-being of the firm. Financial
distress, liquidation and bankruptcy are the ultimate consequences lay ahead if any major
misjudgement occurred following any financing decision of the firms activity.
To date, the literature has focused either on the capital structure determinants of the SMEs of
a single country (e.g. Romano et al., 2000; Degryse et al., 2009) or on cross-country
comparisons (Psillaki and Daskalakis, 2009; Bell and Vos, 2009; Beck et al., 2008). Most
theoretical and empirical studies of SMEs finance focus on Western SMEs. Only a limited
number of studies on SMEs finance have been conducted in Asia especially Malaysia.
Besides, comparison studies among ethnic groups in relation to SMEs capital structure
determinants are still rare in international research and to the best knowledge of the author,
there is none of such research had been conducted in Malaysia. Alternatively, it is mostly
conducted in Western countries such as a study done by Robb and Fairlie (2007) who
investigated on the capital structure of SMEs in African American firms, and Smallbone et al.
(2003) that compared between ethnic minority and White business owners in the United
Kingdoms SMEs.
Additionally, there are still a relatively few empirical studies exploring the perception of
owners-managers in the finance even though they actually play a vital role in SMEs
financing decision. Alternatively, most of the studies in capital structure determinants
1

East Coast Economic Region (ECER) is one of the Malaysia Development Plan. It
was introduced by Malaysian 5th Prime Minister, Y.A.B Dato Seri Abdullah Bin Hj. Ahmad
Badawi. This region consists of four states which covers 51% of Peninsular Malaysia.
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HAFIZAH MAT NAWI (Registration Number: 0734133)

ANNUAL REVIEW (2010)

obtained information from secondary sources of panel data such as Affrsdata, Datastream,
Osiris database, Global Vantage database, Compustat, (CRSP) database, public databases,
Worldscope financial data, SABI database, Annual reports, and so on. This study therefore
examines determinants of capital structure and investigates empirically the financing patterns
of Malaysians (three major ethnic groups) SMEs owners.
Briefly, in this study, researcher is trying to understand from organizations about how they
choose their financing sources. Other than that, we analyse the published reports to analyse
some factors that exist in Malaysia which are different from other countries such as
economics, culture, trend, etc. The differences will be added as variables to the proposed new
framework to Malaysian capital structure determinants.
This report illustrates the following issues: (1) Theoretical background; (2) Aims and
Research questions; (3) Research methodology; (4) Research Framework and proposed
hypothesis; (5) Limitation of the study; (6) Conclusions; (7) Timetable of the progress of the
research during the past year; (8) Lists of skills or training courses attended and future
training needed; (9) Details of the works that have been carried out, problems encountered
and how they were overcome; and (10) Future plans.
Theoretical Background
The theories of capital structure are among the most interesting in the field of finance. The
theories give explanations for questions like how companies choose their capital structure,
what sources of finance should companies choose for different stages of life-cycle, how much
companies should borrow or issue and so on. Even there is no exact formula available for
establishing optimal target debt and capital ratio, empirical studies indicate that profitability,
assets structure, business life-cycle, business size, information asymmetry, business
networking and so forth should be considered when formulating capital structure strategy.
This study considers two main theories; i). Pecking Order Theory (Myers and Majluf, 1984)
which suggests that companies follow a hierarchical order of financing sources, and that they
would begin with internal sources of finance (owner equity and retained earnings), followed
by debt (short-term or long-term debt) if further finance is required, and the last resort is an
external equity (Myers, 1984; Gibson, 2001; Chittenden et al., 1996); and ii). Trade-Off
Theory (Modigliani and Miller, 1963) which involves trade-off between the tax benefits of
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ANNUAL REVIEW (2010)

debt financing and the costs of financial distress such as bankruptcy, predicts that an optimal
target financial debt ratio exists, which will maximize the value of the firm. Both theories
have been adopted by previous researchers as a theoretical foundation to investigate the
determinants of capital structure. Some additional theories are included in this study; Agency
Theory (Jensen and Meckling, 1976), Information Asymmetry (Myers and Majluf, 1984), and
Free Cash Flow Problem (Jensen, 1986).
Aims and Research Questions
Capital structure is a topic that has received much attention in the financial management
field. However, despite the extensive body of literature surrounding the question of an
optimal capital structure and the numerous attempts to explain capital structure determinants,
efforts have proved to be inconclusive (Harris and Raviv, 1991). SMEs finance issues in
Malaysia is in a primary stage and most of the constructs of this research have not been
examined empirically previously. The purpose of this study is to analyze the determinants of
capital structure of Malaysias SMEs (East-coast region) in the light of the Pecking Order
theory, Trade-Off theory, and other related theories.
Specifically, this study aims to examine the effects of the SMEs characteristics, the owners
characteristics and business-lender relationship as well as cultural factors on owners capital
structure decision, to investigate the different financial sources available for different ethnic
groups (indigenous Malay, Chinese, and Indian) in Malaysia, to highlight similarities and
differences of capital structure determinant between these ethnic groups, to look at how the
financing decisions affect the organizations performance, to expand literature about SMEs
finance in Asian countries specifically in Malaysia, and to develop a new model of capital
structure determinants.
In order to provide a formulation of the aim of the study, the primary research question is
posed: What are the factors which influence the financing decisions of three different ethnic
groups in Malaysias SMEs?
Accordingly, this study is trying to answer the following questions.
R1: Does firms characteristics affect the selection of SOF?
R2: Does owners characteristics affect the selection of SOF?
R3: Does business-lender relationship can be one of the determinants of companys capital
structure?
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R4: Do ethnicity differences differentiate the pattern of financing preference of the owner?
R5: How the capital structure decisions affect the companys performance financially or nonfinancially?
Research Methodology
This chapter will address itself to the methodology adopted for the study. The rationale for
the choice of methodology is discussed. The following methodological constraints relevant to
the study are highlighted.
Essentially, SMEs finance is broadly discussed by many scholars and most of the studies
focus on western. Only a limited empirical studies had been done in Asia especially Malaysia.
Thus, the sample of this research will include SMEs in Malaysia. The list of companies will
be taken from SME Corporation of Malaysia.
Until now, this proposed research methodology will be conducted by using a mixed-method
research. At an initial stage, a conceptual model and hypothesis were generated from the
secondary data and an exploration in detail of the design of a particular countrys capital
structure determinants had been taken. After a review of literature in the area of SMEs
capital structure determinants, this research decides to adopt a qualitative approach in an
initial exploratory phase in order to obtain relevant information regarding the new construct
of capital structure decisions.
Prior to the primary data collection (survey questionnaires), the researcher had conducted a
pre-pilot interviews, interviews, and pilot study. A pre-pilot test of five SMEs was conducted
in the U.K on January 2010 to test the level of understanding of the questions among business
owners. Later, ten semi-structured interviews with the owners of SMEs have been conducted
in Malaysia in early May 2010. By employing a qualitative approach, it enables the author to
identify new factors which are not included in the existing models. In addition, based on
literature and primary qualitative data, the aim is to provide an accurate concept of the
relevant constructs, in order to assess the conceptual research framework including the
proposed hypotheses and to ensure face validity and content validity of measurement scales.
Subsequently, the questionnaires were piloted between 15th May 2010 and 25th June 2010.
The pilot study aims at both to evaluate the reliability and level of and content validity, as
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ANNUAL REVIEW (2010)

well as to ensure that the instructions, questions and scale items are clear and understandable.
Thirty copies of the questionnaire were distributed and collected on the spot by the
researcher. Since this study applied self-administered survey method, therefore, the response
rate is 100 percent. The respondents consist of 25 SMEs and 5 academics. After collecting the
questionnaires, suggestions for possible improvements were discussed with respondents.
Appropriate modifications were introduced in order to situate the financing choice measures
within the Malaysia context.
In the next stage, a quantitative method will be used in order to test the proposed hypotheses.
The quantitative data for the main study will be gathered by using survey questionnaires,
which will be distributed to the specific SMEs in the east-coast region of Malaysia and will
be conducted between 15th July 2010 and in the middle of September, 2010. At this point,
structural equation modelling (SEM) using SPSS 15.0 is planned in order to test the proposed
hypothesis.

Research Framework and Proposed Hypothesis

This study will empirically test hypotheses formulated from theories of capital structure by
investigating the influence of a number of generic (firms characteristics, owners
characteristics, business-lender relationship) and cultural determinants on SME financing.
The dependent variables used in this study are the sources of finance (SOF); which are
internal funds (retained profits and funds from family and friends), debt financing (short-term
and long-term debts), and external equity (venture capital, business angels, private investors).
On the other hand, independent variables consist of firms characteristics (firms age, size,
assets structure, profitability, information asymmetry, and business strategy), owners
characteristics (age, education/experience), business-lender relationship (networking), and
cultural factor (ethnicity).
Proposed Hypothesis
To arrive at an adequate answer to the primary research question, the research will test the
following proposed hypotheses:
i.

Owners age

The age of the owner may influence the financing style of the business. Small business
finance literature suggests that older entrepreneurs tend to be less willing to invest additional
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ANNUAL REVIEW (2010)

finances into their firms (Van der Wijst, 1989). Conversely, young owner may prefer to use
debt financing, in contrast with older owner who favours towards internal financing (Romano
et al., 2000; Bell and Vos, 2009). Thus, the following hypotheses are proposed.
H1A: The age of the owner is related positively to internal funds.
H1B: The age of the owner is related negatively to debt.
H1C: The age of the owner is related negatively to external equity.
ii.

Owners education.

Education can be learned whether through formal or informal ways. Educated owners found
to be more articulate and more likely to persuade the banks that they have a viable
proposition (Smith, 2009).

For this study, researcher considers formal education as a

knowledge or training that can be obtained through thought courses like at school, college or
university; while informal education as a knowledge that can be obtained from life
experience, working experience and so on.
Accordingly, the following hypotheses are proposed.
H2A: The education of the owner is related positively to internal funds.
H2B: The education of the owner is related positively to debt.
H2C: The education of the owner is related negatively to external equity.
iii.

Firms age

Business at different stages of life-cycle will demand different types of finance in running the
business activities (Berger and Udell, 1998; Rocca et al., 2009). For this study, age of the firm
is measured by three stages of life-cycle; start-up, growth and matured stages. Accordingly,
the following hypotheses are proposed.
H3A: The use of the internal funds of the SME owner is negatively related with age.
H3B: The use of debt financing is negatively related with age.
H3C: The use of external equity is negatively related with age.
iv.

Firms size

Firms size can be measured by the logarithm of sales. The larger the size of firm found to be
more favourable towards debt financing (Rocca et al., 2009; Beck et al., 2008; Psillaki and
Daskalakis, 2009). However, this study will use different measurement to measure size of the
firm. The size is measured by the total number of full-time employees (SME Corporation of
Malaysia). Therefore, the following related hypotheses are proposed.
H4A: The size of firm is associated positively with internal funds.
H4B: The size of firm is associated positively with debt.
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H4C: The size of firm is associated positively with external equity.

v.

Asset structure

Asset structure means total tangible assets as a proportion of total assets. Firms with more
tangible assets found to be positively associated with the long-term debt ratio (Rocca et al.,
2009; Degryse et al., 2009). Alternatively, it found to be negatively associated with shortterm debt ratio. The asset structure in this study will be measured based on the rate of change
of total fixed assets over total assets for the recent three years. The more assets the company
has, the more security the company will possess, and this will lead to the more debt financing
the company will be able to request (Degryse et al., 2009).
Accordingly, the following hypotheses are proposed.
H5A: The use of internal funds is positively related with tangible activity
H5B: The asset structure is positively related with the use of debt finance.
H5C: The asset structure is positively related with the use of external equity.
vi.

Profitability

Profitability is defined as the ratio of income before taxes over total assets or is called as a
Return on Asset (ROA). Higher profitability firms usually tend to use internal financing as
much as possible and then raise debt only when additional finance is necessary (Psillaki and
Daskalakis, 2009; Rocca et al., 2009; Degryse et al., 2009). The profitability in this study will
be measured based on the rate of change of earnings before interest and taxes over total assets
for the recent three years.
Accordingly, the following hypotheses are proposed.
H6A: The use of internal funds is positively related with profitability.
H6B: The use of debt is positively related with profitability.
H6C: The use of external equity is positively related with profitability.
vii. Information asymmetry
For SME financing, information asymmetry between the firm and the lender is very
important as well. The more the asymmetries of the information, the harder for the company
to obtain the external financing; and this situation will indirectly increase the use of internal
financing (Rocca et al. 2009; Bell and Vos, 2009).
Accordingly, the following hypotheses are proposed.
H7A: The use of internal funds is positively related with information asymmetry.
H7B: The use of debt is positively related with information asymmetry.
H7C: The use of external equity is positively related with information asymmetry.
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HAFIZAH MAT NAWI (Registration Number: 0734133)

viii.

ANNUAL REVIEW (2010)

Business Strategy

It is common for small business owners to use, at start-up; formal business strategies and
plans as a sales document to obtain debt or other external forms of finance (Berger and Udell
1998). In line with this proposition, Harvey and Evans (1995) found that when evaluating
loans, banks emphasize the importance of effective business planning, which has been shown
to be positively related to debt.
Therefore, the following related hypotheses are proposed.
H8A: Firms that have good business strategies are associated positively with internal funds.
H8B: Firms that have good business strategies are associated positively with debt.
H8C: Firms that have good business strategies are associated positively with external equity.
ix.

Networking

Business and lender are two different identities but are interrelated to each other. Businesses
depend on lenders for their funding and lenders depend on businesses in order to gain an
interest for their extra money. Therefore, good relationship between business and lender is
very important in order to avoid SMEs from facing difficulties in raising external finance
(Scott, 2006). The previous discussion suggests the following hypotheses:
H9A: The use of internal funds is negatively related with networking.
H9B: The closer the relationship between lender and borrower, the easy the accessibility to
debt financing.
H9C: The closer the relationship between lender and borrower, the easy the accessibility to an
external equity.
x.

Ethnicity

Ethnic discrimination will affect the preference of SOF among entrepreneurs, especially
ethnic minority entrepreneurs. Ethnic minority business owners are said to prefer finance
using internal funds instead of external funds (Robb and Fairlie; 2007; Smallbone et al,
2003). In Malaysia, there are three major ethnic groups of SMEs owners. The majority of
Malaysias population are indigenous Malays, with Chinese Malaysians and Indian
Malaysians occupying minority roles.
Thus, the following two hypotheses are proposed.
H10A: The use of internal funds is positively related ethnic minority.
H10B: The use of debt financing is positively related with ethnic minority.
H10C: The use of external equity is positively related with ethnic minority.
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HAFIZAH MAT NAWI (Registration Number: 0734133)

xi.

ANNUAL REVIEW (2010)

Organisational performance

The performance of the firm is highly dependent on the correct usage of SOF. It can be
measured whether financially such as based on companys earnings or non-financially which
are based on new product introduction, product quality, marketing effectiveness, etc.
Therefore, the following related hypotheses are proposed.
H11A: The use of internal funds gives positive impact on the organisational performance.
H11B: The use of debt gives positive impact on the organisational performance.
H11C: The use of external equity gives positive impact on the organisational performance.

Figure 1: Hypothesized model for SMEs Capital Structure Determinants

Personal
Characteristics
(control variable)
Age
Education
/Experience

Internal
Funds

Firms
Characteristics
Age
Size
Assets
structure
Profitability
Information
asymmetry
Business
strategy

Debt
Financing

Business-Lender
Relationship
Networking

External
Equity
Financing

Organizational
Performance

Financial
Non-financial

Cultural factor
Ethnicity

Limitations of the

Environmental
Dimensions
Study Government
Economic
condition
Social Pressure

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HAFIZAH MAT NAWI (Registration Number: 0734133)

ANNUAL REVIEW (2010)

There are several limitations in this study. Firstly, the literature on SMEs SOF is not so
extensive and most of the issues are comparatively new to the context (Malaysia) and it might
cause shortcomings in authors assumptions and findings. Secondly, the samples in this study
include only SMEs which are registered with SME Corporation Malaysia and that the author
may not be able to make generalisations on the ethnicity financing patterns. Finally, the
author may have to deal with a variety of constructs in order to give an overall perspective
instead of focusing on one issue.

Conclusion
The study attempts to provide a better understanding of the determinants of capital structure.
This study also intends to highlight the impact of political, economic and social wellness on
financing decisions. The hypotheses and the integrative framework provide a foundation for
organizations in order to manage SOF. Importantly, this study highlights the differences and
similarities among three major ethnic groups in their financing patterns. This research
includes the variable of ethnicity which has received little attention in the literature.

Table 1: Timetable of the Progress of the Research during the Past Year
Enrolment/Registration
October 2008- Dec 2008
Working with Research gaps, research
framework, research objectives, research
proposal draft, and literature review
Jan 2009- June 2009
Working with research framework and start
(except April & May- Maternity Leave)
writing
July 2009 - August 2009
Writing Chapter 2 & 3
st
1 Annual Review
September 2009- December 2009
Writing Chapter 2 & 3, Preparing
questionnaire
January 2010- February 2010
Pre-testing questionnaire (location : U.K)
March 2010-April 2010
Preparing questionnaire for pilot study
May 2010- June 2010
Conducting interviews and pilot study
(location : Malaysia)
July 2010- end of August 2010
Survey questionnaire (location: Malaysia)
Sept 2010
SPSS and Study 2
nd
2 Annual Review

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HAFIZAH MAT NAWI (Registration Number: 0734133)

ANNUAL REVIEW (2010)

Table 3: Skills/ training courses attended and list of future training needed
Skills/ Training Courses
Early Stage Research Module (GS)
Mid Stage Research Training Module (GS)
Nvivo Research Software (GS)
Giving formal and informal presentations
courses (GS)
Introduction to online statistics (GS)

Future Trainings Needed

SPSS course
Presentation skills course
Journal writing course

Thesis writing course (GS)

Referencing with Refworks (GS)
Research methodology course (BBS)
Introduction to SPSS (BBS)
GS- Graduate School
BBS- Brunel Business School
Table 2: Works that Have Been Carried out
Works carried
Problems
out
Literature
- Few literature on Malaysian
review
SMEs finance
Questionnaire
development
and design

Problems in:
i.
Specifying what
information will be sought
ii.
Deciding the type and form
of each question, and
method of administration
iii.
Determining the content of
individual questions
iv. Deciding on question
wording and question
sequencing
v. Determining scales of
measurement
vi.
Translation of the research
instrument

Interview in the

Problem in finding small business

Solutions
- Search on various literature from all
countries and cultures.
- Getting data from SME Corporation for
Malaysian SMEs information.
After thoroughly review of literatures in the
SME finance area, specifically related with
capital structure determinants issue; and
after discussing with the supervisor, the
problems had been solved.
i. Information : SMEs financing choices
ii. Method: Self-administered questionnaire
iii. Contents: Business financing,
information on business owner and
enterprise, as well as companys
performance.
iv. Question sequencing: Starting with key
information needed by the researcher
(e.g. business financing) and ending with
information on companys performance.
v. Scales: Most of the questions are
measured by using Liked-scale.
vi. Translation:
English- Malay-English (done)
- English- Mandarin- English (still in
process)
- Obtained the list of companies in
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HAFIZAH MAT NAWI (Registration Number: 0734133)

U.K

in Uxbridge and London areas.

-

Interview in
Malaysia

Problem in getting cooperation

from SMEs owners.

Pilot testing
(Malaysia)

Same problem as interview, which

is problem in getting cooperation
from SMEs owner, especially
Chinese business owners.
Problem of collection- Most of the
respondents did not answer the
questionnaires when the researcher
left them to be completed

Survey
Questionnaire

ANNUAL REVIEW (2010)

Hillingdon from Brunel Career and

Placement Centre.
Obtained the list of Malaysian companies
in the UK from Malaysian Students
Department
This problem was overcome when the
researcher used her official title in
University Malaysia Kelantan (one of the
public universities in Malaysia).
This problem was overcome when the
researcher approached them (business
owners) by communicating in their
mother tongue which is Mandarin
The researcher resolved the problem by
personally asking the questions on the
spot.

Future Plans
i.

Continue in preparing solid literature and methodology.

ii.

Collecting data for primary study (survey).

iii.

Attending and presenting at conferences.

iv.

Analysing the data.

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[Accessed

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