Limited Attention and Debt Financing of Small Firms

1. Limited Attention and Debt Financing of Small Firms Shujun Ding York University, Canada Chunxin Jia Peking University, China Zhenyu Wu University of Saskatchewan, Canada Wenlong Yuan University of Lethbridge, Canada

2. Motivation • Debt financing is vital to the survival and growth of small firms. • Scholars have paid scant attention to the potential of advertising as a linking mechanism between small business borrowers and lenders. • Limited attention in stock market • Barber and Odean, 2008 • Is there limited attention in the debt market?

3. Literature Review • Advertising and limited attention in product market • Nelson 1974; Kihlstrom and Riordan 1984; Vakratsas and Ambler 1999; Fluet and Garella 2002 • Firm may use advertising to communicate to shareholders and signal the value of its projects to the financial markets. • Chemmanur and Yan (2009)

4. Literature Review • Information asymmetry that exists between lenders and privately held small business borrowers • (Jensen and Meckling 1976; Leland and Pyle 1977; Myers 1977; Smith and Warner 1979; Stiglitz and Weiss 1981; Diamond 1984, 1991; Harris and Raviv 1990, 1991; Petersen and Rajan 1994, 1995, 2002; Berger and Udell 1995, 1998, 2002; Shleifer and Vishny 1997) • There remains a lack of research on the role of advertising in small business debt financing, either as a way of mitigating information asymmetry or as a mechanism for attracting the attention of lenders.

5. Literature Review • Both the limited information processing capacity of decision-makers and information overloading may result in decision-makers responding to a limited number of issues. • Miller 1956 • Schwarz and Clore (1983) • Hirshleifer and Shumway 2003

6. Hypothesis Development • In the lending market, big firms are more prominent than others • There are too many small firms and it is difficult to differentiate them from each other • Advertising may influence the cognitive processes of loan officers • Loan officers may experience a brief information verification process. • Advertising may provide loan officers with stronger incentives to process soft information.

7. Hypothesis Development • Big firms have more verifiable information for banks to process, banks mainly depend on score ratings • Small firm lending Vs stock investment of retail investors: • Banks in debt market: Many choice, ability to process, insufficient verifiable information • Retail investors in stock market: Many choice, inability to process, sufficient verifiable information • Hypothesis 1a: Larger firms with higher advertising expenditure do not have greater financial leverage. • Hypothesis 1b: Smaller firms with higher advertising expenditure have greater financial leverage.

8. Data and methodology • Chinese Industrial Enterprises Database (CIED) published by the National Bureau of Statistics of China. • 2003 to 2007, totally 1,386,878 observations • Model: • Dependent Variablet = α0 + α1Independent Variablet-1 + α2Control Variables + ε1, (1)

9. Data and methodology • Dependent variable is either TL/TAt, LTD/TAt, or IBL/TAt • Independent variable is either AdvExpLnt-1, Adv/Revt-1, or Adv/TAt-1 • Taking into account the nonlinearity • Sensitivity analysis

10. Table 1 Descriptive Statistics

11. Main Findings • Expenditure on advertising in the past year significantly increases financial leverage in the current year in small firms, but not in large ones • Positive relationship is stronger when firms are smaller than when they are bigger • Advertising is not effective in drawing creditors’ attention when sales growth provides them with more concrete information • The positive advertising-financial leverage relationship could be even more significant when the marketization level is high

12. Table 3 Financial Leverage and Lagged Advertising Expense:Panel A. Results from Model (1) with the Dependent Variable LTD/TA

13. Panel B. Results from Model (2) Using the Subsample of Small firms

14. Table 4 Sensitivity Analysisbetween Financial Leverage and Advertising Expenses

15. Is the Decision of Lending More to Firms that Advertise Based on Profitability? • Rational Vs Behavior • Profitability = γ0 + γ1Advertising + γ2Control Variables + ε4 • Advertising expenses may even lower the net profit margins of small firms

16. Table 5 The Relationship Between Profitability and Advertising Expenses

17. Do Small Firms Increase Advertising Expensesso as to Access Debt Financing • Advertisingt = δ0 + δ1Financial Leveraget-1 + δ2Control Variables + ε5, (5) • Firms, especially small ones, do not increase their advertising expenses intentionally to achieve greater financial leverage • Not completely consistent with that of Chemmanur and Yan (2009) : Equity Vs debt

18. Table 6 The Relationship Between Advertising Expense and Lagged Financial Leverage

19. Do Lenders View Advertising as a Credible Signal • Active signaling Vs passively taking signal • AIRt = ζ0 + ζ1Advertising + ζ2Control Variables + ε6, (6) • Advertising effect is limited to access to finance ONLY because the information asymmetry issue is not mitigated and the cost of debt is not reduced • Attracted Vs convinced

20. Table 7 The Relationship Between the Average Interest Rate and Advertising Expenses

21. Conclusion Examine small business financing issue by incorporating relevant theories and findings from behavioral finance, psychology, entrepreneurship, and marketing. Extends the application of the limited attention theory to the field of small business debt financing

22. Conclusion Higher advertising expenditure is not driven by small firms with lower financial leverage and that it is not associated with higher annual profitability/cost efficiency. Although these firms may expect to have greater access to financing, their informational asymmetry problem with lenders is not mitigated.

23. Thank You!