What do we know about the relationship between corporate leverage and small business investment in human capital? Not that much has been explored on the subject: Ramzi Benkraiem, Professor of finance at Audencia, fills the gap with this latest article : Corporate leverage and the terms of employment: evidence from French small businesses before and during the global crisis *.
The investment in human capital expenditure is a key issue which determines the competitiveness and success of Small and Medium-sized Enterprises (SMEs). According to recent French governmental statistics, firms with fewer than 250 employees concentrate 55% of all the employees working in the private sector. On the other hand, corporate leverage is a fundamental concern which conditions the long-lasting viability of these businesses. The European Commission places a major emphasis to the financing practices and options of SMEs. Despite the importance of these two factors for this category of firms, little is surprisingly known about the relationship between corporate leverage and small business investment in human capital.
In this article, we attempt to fill this gap by investigating how corporate leverage is related to small business human capital examined through the investment in employee-related expenditure. There are important potential arguments for why leverage should be relevant to firm investment in employee-related expenditure. These arguments highlight costs related to human capital and conflicts of interests which oppose inter alia corporate managers to fund providers. The magnitude of the mentioned costs may result in manager incentives to over or underinvest in employee-related expenditure. By doing so, corporate managers are likely to obtain private benefits, sometimes at the expense of fund providers. Costs related to human capital and conflicts of interests are particularly important for small businesses because of a relatively high informational opacity and default risk. Thus, consequences of these costs on investment in employee-related expenditure could be particularly striking for the specific case of SMEs. Moreover and according to the Bank of France, the 2008 global crisis has significantly affected leverage availability as well as bankruptcy risk, especially for SMEs. As such, the extent of the influence of leverage on SME investment in employee-related expenditure is likely to be different before and during the crisis period.
So what are the conclusions? We find that corporate leverage serves as a monitoring mechanism of mangers prone to over or underinvest in employee-related expenditure to obtain private benefits. Due notably to the availability of debt, this monitoring is more effective before the crisis period, especially for low growth firms. Overall, these results provide support to the theory that leverage has a disciplining role. Simultaneously, they lead to moderate the strength of this role according to the global crisis. This study provides a level of analysis unmatched by previous research on small businesses, especially in times of crisis. Thus, it provides useful insights for academics, regulators, managers as well as credit institutions.
*Written with Mondher Bouattour, Antony Miloudi and Ludovic Vigneron, and published in Applied Economics.