Information Asymmetry, Small Firm Finance and the Role of Government

Abstract

AbstractOne of the most important and commonly quoted constraints upon the survival and ultimate growthof the firm is its ability to raise financial capital. As early as 1931, with the publication of theMacmillan Report, it has been suggested that a 'finance gap' exists for small firms owing to their disadvantaged position in the market for bank finance. It is argued by many that the fundamentalcause of this finance gap is the information asymmetry that exists between the provider and thecandidate recipient of finance. Arguably, the information asymmetry problem has been exacerbatedin recent years by further centralisation in bank lending decisions and the introduction of computerised business credit-scoring.The aim of this paper is to examine the proposition that informal forms of finance might play a significant role in overcoming both information asymmetry and the finance gap. To achieve this aim,a broad conceptualisation of the various types of non-bank finance (termed ‘quasi-commercial’(QCOM) finance) is adopted to demonstrate their potential role in addressing these related problems.Through grounding interviews, a model is developed to demonstrate the position of different QCOMproviders in the small firm finance market. Finally, the results of a survey to determine the currentawareness and use of various forms of finance by small firms are presented. These results suggestthat for many UK firms, a finance gap is not perceived to exist and that the use of non-bank financeremains very limited. Policy recommendations are made on the basis of the findings.Introduction and BackgroundThe aim of this paper is to determine how small firms currently obtain their finance and to explorethe nature of the financing constraints they experience, with particular reference to the market failure of information asymmetry. This research constitutes part of a wider ACCA funded researchproject which seeks to investigate the use of various sources of informal finance by small firms,focusing in particular on the impact of the firm's strategic objectives and its stage of developmenton this use.The paper will commence with a review of the literature concerning the small firm finance gap andwill explore the problem of information asymmetry in the financing process. The methodology willthen be discussed, describing the grounding interviews and survey employed. The results of the primary research are then explained and drawn together in a conclusion which discusses the salientfindings and discusses implications for both small firms and policy makers.

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