Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 3 FIRM CHARACTERISTICS, DEBT MATURITY STRUCTURE, AND INNOVATION PERFORMANCE OF SMALL FIRMS Alenka Slavec Gomezel Ekonomska fakulteta Univerze v Ljubljani alenka.slavec@ef.uni ‐lj.si Abstract Based on a large sample of 497 small Slovenian manufactory firms and applying structural equa ti on modeling, we in ‐ ves ti gate the rela ti onship between six di fferent firm characteris ti cs (firm legal status, firm age, assets tangibility, cash flow, long ‐term financing of long ‐term assets and inventories ra ti o, and the quick ra ti o) and debt maturity structure of small firms in terms of short ‐term debt and long ‐term debt. In addi ti on, we uncover the rela ti onship between debt maturity structure and innova ti on performance of small firms. The results of our study point to the importance of ex ‐ ternal financial sources for firm innova ti on performance and to the relevance of specific firm characteris ti cs to explain debt maturity structure of small firms. Keywords: firm characteris ti cs, debt maturity structure, small firms, innova ti on, short ‐term debt, long ‐term debt 1 INTRODUCTION Small firms are widely recognized as drivers of innova ti on (Bardos, Planes, Avouyi ‐Dovi, & Sevestre, 2002) and a vital determinant of the economic growth (Beck & Demirguc ‐Kunt, 2006) and compe ti ‐ ti veness of a na ti on. For small firms to grow, de ‐ velop, and innovate, it is important that an economy provides a suppor ti ve environment. In par ti cular, having a suppor ti ve and e fficient financial sector is crucial, but small firms s ti ll face obstacles in obtain ‐ ing external funds (Ayyagari, Beck, & Demirguc ‐ Kunt, 2007; Berger & Udell, 2006; Czarnitzki & Ho tt enro tt , 2011; Qorraj, 2017). This leads re ‐ searchers to focus their inves ti ga ti ons on firm and owner determinants that influence small ‐firm fi ‐ nancing in general, or to focus par ti cularly on di ffer ‐ ent types of financing, e.g., bank loans (e.g. Berger & Udell, 1998; Liao, Chen, & Lu, 2009), trade credits (e.g. Aaronson, Bos ti c, Huck, & Townsend, 2004; Cunat, 2007; Huyghebaert, Van de Gucht, & Van Hulle, 2007), venture capital (e.g. Davila, Foster, & Gupta, 2003), etc. By contrast, less a tt en ti on has been paid to the rela ti onship between a vast range of firm characteris ti cs, including financial ra ti os, and the debt maturity of small firms in terms of short ‐ term debt and long ‐term debt. The mo ti va ti on for this study comes from three sources. First, there is a shortage of research on the rela ti onship between firm characteris ti cs and the maturity structure of small ‐firm debt (González Méndez, 2013). Second, the predica ti ve ability of firm indicators is an important source of informa ti on for the decisions a small firm to finance or not (Bot ‐ tazzi, Secchi, & Tamagni, 2014). Third, such research has prac ti cal implica ti ons for firms that want to apply for external financial resources to fund their innova ti on ac ti vi ti es. This study contributes to the entrepreneurial finance and innova ti on literature by be tt er understanding the financial determinants of small ‐firm innova ti on performance. We highlight the need to make the financial market more acces ‐ sible for small firms in order for firms to boost their innova ti on poten ti al. The rest of the paper is organized as follows. First, we develop our 16 research hypotheses by re ‐ viewing the literature based on which we present Vol. 11, No. 1, 3 ‐15 doi:10.17708/DRMJ.2022.v11n01a01 Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 4 Alenka Slavec Gomezel: Firm Characteris ti cs, Debt Maturity Structure, and Innova ti on Performance of Small Firms the proposed model of small ‐firm financing through short ‐term debt and long ‐term debt. We con ti nue with a brief explana ti on of the methodology, sam ‐ ple, and research data. Then we present research findings. The paper concludes with the discussion of results and recommenda ti ons for firms to obtain external financial sources. 2 THEORETICAL BACKGROUND Although small firms are recognized as an im ‐ portant part of the economy (Berger & Frame, 2007), they face constraints in raising external fi ‐ nancing. One of the main reasons is banks’ prefer ‐ ence to lend to a smaller number of large clients rather than to numerous smaller firms (Hyy ti nen & Vaananen, 2006) because of the higher failure risk faced by small firms. In order to compensate for the higher risk of failure and higher costs of informa ti on collec ti on, lenders charge rela ti vely high interest rates to smaller firms (Hyy ti nen & Pajarinen, 2007). Moreover, many studies revealed that the availabil ‐ ity of external financial sources for small firms is constrained due to asymmetric informa ti on, opacity, moral hazard, adverse selec ti on, non ‐obligatory au ‐ di ti ng of financial statements, and insu fficient avail ‐ ability of informa ti on for the public (Berger & Frame, 2007; Berger & Udell, 1998; Hyy ti nen & Vaananen, 2006; Vos, Yeh, Carter, & Tagg, 2007). To mi ti gate or even avoid these unfavorable small ‐firm determinants, lenders take into consid ‐ era ti on some typical firm and owner characteris ti cs that help them in the lending decision process. However, the rela ti onship between some firm char ‐ acteris ti cs, especially financial ra ti os calculated from financial statement data, and the availability of external financial sources (debt) and specifically the maturity of debt remains underexplored. More ‐ over, some scholars argue that debt is mainly a func ti on of firm characteris ti cs rather than owner characteris ti cs (e.g. Coleman & Cohn, 2000). Aste ‐ bro and Bernhardt (2003) also suggested that finan ‐ cial ins ti tu ti ons focus on financial evidence of creditability, as opposed to informa ti on about owner capabili ti es. Furthermore, many studies an ‐ alyzed how di fferent indicators or financial ra ti os predict the survivor or failure of a firm and capture a gradua ti on of the severity of credit problems that a firm and lender may face (e.g. Bo tt azzi et al., 2014; Slavec Gomezel, 2017; Zimmer, 1980). Thus, financial ins ti tu ti ons and other lenders should take these indicators or financial ra ti os into account when lending to small firms, because these ra ti os have a great predica ti ve ability. For these reasons, this paper focuses on firm characteris ti cs, adding to the research some underexplored financial ra ti os and their rela ti ons to external debt. In addi ti on to the lack of inves ti ga ti on of the re ‐ la ti onship between financial ra ti os and small ‐firm fi ‐ nancing in general, there is also a gap in the literature regarding the rela ti onship between finan ‐ cial ra ti os and other firm characteris ti cs and the ma ‐ turity structure of debt, that is, short ‐term debt and long ‐term debt. Specifically, there is a need to clarify the rela ti onships of cash flow, long ‐term financing of long ‐term assets and inventories ra ti o, and the quick ra ti o on short ‐term debt and long term ‐debt. Our research addresses this gap. We also inves ti gate the rela ti onship between short ‐term debt and long term ‐debt and innova ti on performance of small firms. The proposed structural model is shown in Figure 1, whereas the proposed hypotheses are pre ‐ sented in the con ti nua ti on of the paper. 2.1 Legal status and debt maturity structure Small firms in Slovenia are usually formed as sole proprietorships or limited liability companies, and only a minor por ti on of small firms are formed as incorporated companies. There are several rea ‐ sons for this structure: the minimum capital require ‐ ment to establish an incorporated company is higher, bureaucra ti c costs and opera ti ons are sub ‐ stan ti al, financial statements need to be audited, and disclosure of informa ti on is obligatory. When making a decision between a sole pro ‐ prietorship and a limited liability company, several factors should be taken into account. Forming a sole proprietorship is easier because there is no need to pay in any start ‐up capital, whereas the capital requirement for a limited liability company amounts to EUR 7,500. Bureaucratic procedures for establishing a limited liability company are greater than those for a sole proprietorship, and Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 5 operating requirements and costs are higher for a limited liability company, as well. Managing a sole proprietorship is easier and less formal. On the other hand, a sole proprietorship does not have the status of an entity, and as such has less credi ‐ bility from lenders’ and other partners’ points of view. Moreover, members of a limited liability company are not liable for the firm’s liabilities with all of their property but only with their stake of capital paid in. However, lenders often require owners’ personal guarantees for obtaining loans. Furthermore, the easy availability of limited liabil ‐ ity provides an incentive for small ‐firm owners to undertake unduly risky ventures in the belief that they are protected and can shift the risk to others at no or little cost to themselves. Freedman (2000) argued that the costs of monitoring are lower for a limited liability company than for a sole propri ‐ etorship. All these factors lead us to the assump ‐ tion that sole proprietorships have fewer external financial sources, as was shown by previous re ‐ search (Coleman & Cohn, 2000; Petersen & Rajan, 1994; Storey, 1994). Moreover, we also assume that for the same reasons, sole proprietors will have fewer external financial sources in terms of short ‐term debt and long ‐term debt because sole proprietorship have less credibility and ability to settle debts. Based on this discussion, the first two hypotheses are postulated as follows: Hypothesis 1a: The legal status of the firm a ffects the debt maturity structure – sole proprietorships will get less short ‐term debt. Hypothesis 1b: The legal status of the firm affects the debt maturity structure – sole proprietorships will get less long ‐term debt. 2.2 Firm age and debt maturity structure Petersen and Rajan (1994) found that leverage decreases with age, meaning that older firms borrow less because they finance their ac ti vi ti es more with retained earnings. Similar findings were reported by Michaelas et al. (1999). Hall et al. (2000) proved that long ‐term debt is related posi ti vely to age, whereas short ‐term debt is nega ti vely related to age. Hall et al. (2004) found significant evidence that older SMEs in Spain, the UK, and Italy rely more on internally generated funds, because the rela ti onship between age and long ‐term debt was sta ti s ti cally significant and nega ti ve. Based on the findings of these studies, two more hypotheses are postulated: Hypothesis 2a: Age is nega ti vely related to debt – older firms borrow less on a short ‐term basis. Hypothesis 2b: Age is nega ti vely related to debt – older firms borrow less on a long ‐term basis. Figure 1: Conceptual model of small ‐firm financing through short ‐term debt and long ‐term debt total assets is negatively associated with short ‐ term debt. Therefore we postulate the next two hypotheses: Hypothesis 3a: Tangibility of assets is nega ti vely re ‐ lated to short ‐term debt. Hypothesis 3b: Tangibility of assets is posi ti vely re ‐ lated to long ‐term debt. 2.4 Cash flow and debt maturity structure Cash flow, which is determined as profits plus deprecia ti on, represents an internally generated source of financing (Rivaud ‐Danset, Dubocage, & Salais, 1998) that can eventually assure the solvency of a firm or can act as a safety reserve in case of crises. On the other hand, cash flow can convey valu ‐ able informa ti on about a firm’s investments decisions (Rodríguez, Muiño, & Lamas, 2012), and communi ‐ cates to lenders the financial health and stability of the firm (Rivaud ‐Danset et al., 1998). The pecking order theory suggested by Myers (1984) supposes that firms finance their needs in a hi ‐ erarchical order, first using internally available funds, followed by debt, and finally external equity. This pref ‐ erence reflects the rela ti ve costs of the various sources of financing, due to the existence of informa ‐ ti on asymmetries. The pecking order hypothesis is parti cularly relevant for small firms because the costs of external equity may be higher for small firms than for larger ones (Michaelas et al., 1999) and have the addi ti onal weakness of losing the total control of the firm because new stock owners come into the firm (S ti glitz & Weiss, 1981). The most favorable financial sources for small firms are those generated in the firm. This indicates that firms which generate enough funds for further investment and growth internally will not need to borrow outside the firm (Degryse, de Goeij, & Kappert, 2012). This can lead to the assump ‐ ti on that larger cash flows are nega ti vely related to ex ‐ ternal financial sources in terms of short ‐term debt and long ‐term debt. This assump ti on has been ap ‐ plied by di fferent scholars. Hall et al. (2004), for exam ‐ ple, suggested that with regard to profitability, it is assumed that internally generated funds are preferred to externally generated funds, and therefore prof ‐ itability is nega ti vely correlated with the amount bor ‐ Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 6 2.3 Tangibility of assets and debt maturity structure Tangible assets, which a firm owns, are an im ‐ portant source of securing debt. These assets can be pledged as collateral (Salgador, Brito, & Do ‐ nate, 2011). Collateral lowers monitoring costs, which are experienced as a consequence of moral hazard and adverse selection (Jimenez, Salas, & Saurina, 2006; Stiglitz & Weiss, 1981). Thus, a firm with a larger proportion of tangible assets (land, factories, engines, etc.) to total assets will more often apply for credit because it has more collat ‐ eral to offer. Several authors (e.g., Leeth & Sco tt , 1989; Sal ‐ gador et al., 2011) argued that the longer the ma ‐ turity of debt, the higher is the probability of collateral requirements for a firm. Moreover, debt secured with tangible assets is posi ti vely linked with debt maturity (Leeth & Sco tt , 1989). Chi tt en ‐ den et al. (1996) pointed out that a high fixed ‐asset component and a high inventory level are associ ‐ ated with higher short ‐term and long ‐term debt, leading to the conclusion that small firms with a high propor ti on of fixed assets are able to raise higher levels of debt financing. Although more tan ‐ gible assets as a propor ti on of total assets suggests a higher chance of approved long ‐term debt, Michaelas et al. (1999) found a posi ti ve rela ti onship between the tangibility of assets and short ‐term debt. On the other hand, Chi tt enden et al. (1996) and Van der Wijst and Thurik (1993) argued that there is a nega ti ve rela ti onship between tangible assets and short ‐term debt, and a posi ti ve rela ti on ‐ ship between tangible assets and long ‐term debt. The same results were confirmed by Hall et al. (2000, 2004), who found that long ‐term debt is posi ti vely related to asset structure (ra ti o of tangi ‐ ble assets to total assets) and short ‐term debt is nega ti vely related to asset structure. Based on this discussion, we can assume that firms with a higher proportion of tangible assets to total assets will have a less ‐constrained access to debt financing because tangible assets can be pledged as collateral. A larger volume of collateral thus predicts a higher probability of approved long ‐term debt. On the other hand, some scholars found that a larger proportion of tangible assets to Alenka Slavec Gomezel: Firm Characteris ti cs, Debt Maturity Structure, and Innova ti on Performance of Small Firms Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 7 rowed by firms in both the long and the short terms. In other words, a firm which can generate more earn ‐ ings will borrow less, all things being equal (Adedeji, 1998; Hall et al., 2004; Rodríguez et al., 2012). Hall et al. (2004) showed a nega ti ve associa ti on between profitability and short ‐term debt, whereas there was no significant associa ti on between profitability and long ‐term debt. Based on this discussion, our next hy ‐ potheses are postulated: Hypothesis 4a: Cash flow is negati vely related to short ‐term debt. Hypothesis 4b: Cash flow is nega ti vely related to long ‐term debt. 2.5 Long ‐term financing of long ‐term assets and inventories ra ti o and debt maturity structure The obtained values of the ra ti o of long ‐term fi ‐ nancing of long ‐term assets and inventories indicate the solvency of the firm in a given moment. With this ra ti o we show the long ‐term financing of long ‐term assets and of the least ‐liquid short ‐term assets – in ‐ ventories. Indirectly, it shows us two things: (1) the adjustment of the structure of assets and the struc ‐ ture of liabili ti es and (2) the surplus of long ‐term lia ‐ bili ti es over long ‐term assets. The recommended value of the long ‐term financing of long ‐term assets and inventories ra ti o is higher than or equal to 1. This suggests that firms finance long ‐term assets and the propor ti on of inventories that is necessary for uncon ‐ strained firm opera ti ons with long ‐term liabili ti es. Chi tt enden and Bragg (1997) argued that long ‐ term debt represents only a minor percentage of a firm`s liabili ti es. According to the pecking order the ‐ ory, SMEs prefer internal funds over external funds (Degryse et al., 2012). Consequently, long ‐term as ‐ sets are predominantly financed by equity and short ‐term debt. Furthermore, if a firm finances its inventories and long ‐term assets with long ‐term fi ‐ nancial sources, it will not need short ‐term financial sources for financing inventories and long ‐term as ‐ sets. This leads us to the assump ti on that the long ‐ term financing of long ‐term assets and inventories ra ti o will have a nega ti ve associa ti on with short ‐ term debt. Higher values of the long ‐term financing of long ‐term assets and inventories ra ti o also sug ‐ gest that in the extreme case a firm will finance all assets, including short ‐term assets other than inven ‐ tories, with long ‐term liabili ti es. In this case a firm will not need addi ti onal debt and the long ‐term fi ‐ nancing of long ‐term assets and inventories ra ti o will have a nega ti ve associa ti on with further indebt ‐ edness of a firm, which leads us to the postula ti on of these two hypotheses: Hypothesis 5a: Long ‐term financing of long ‐term as ‐ sets and inventories ra ti o is nega ti vely related to short ‐term debt. Hypothesis 5b: Long ‐term financing of long ‐term assets and inventories ra ti o is nega ti vely related to short ‐term debt. 2.6 Quick ra ti o and debt maturity structure The basis on which to calculate ra ti os for short ‐ term financial equilibrium es ti ma ti on is a sub ‐balance which presents short ‐term assets and short ‐term lia ‐ bili ti es. However, adjustment of the structure of as ‐ sets and liabili ti es does not ensure financial liquidity of the firm. Thus, the level of cash and highly liquid assets (marketable securi ti es) compared to short ‐ term liabili ti es is also of high importance. The quick ra ti o shows whether or not the most liquid assets are financed with short ‐term liabili ti es. If the value of the quick ra ti o exceeds 1, this means that in addi ti on to inventories, more liquid assets are being financed with long ‐term liabili ti es. Higher quick ra ti os suggest higher solvency of firms, which from the lender’s point of view acts as an ac ‐ celerator in the lending process. However, from the firm’s point of view, higher liquidity means less re ‐ liance on borrowers, because firms have enough fi ‐ nancial sources. Thus, we presume that the la tt er e ffect will prevail, and therefore we expect a nega ‐ ti ve rela ti onship between the quick ra ti o and short ‐ term and long ‐term debt. Consequently, the next two hypotheses are postulated as follows: Hypothesis 6a: Quick rati o is nega ti vely related to short ‐term debt. Hypothesis 6b: Quick ra ti o is nega ti vely related to long ‐term debt. Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 8 Alenka Slavec Gomezel: Firm Characteris ti cs, Debt Maturity Structure, and Innova ti on Performance of Small Firms 3 METHODOLOGY In this part of the paper we discuss the method ‐ ology used in our study in terms of sampling and data analysis and in terms of opera ti onaliza ti on and measure valida ti on. 3.1 Sample and data analysis The research sample consisted of entrepreneurs who answered a survey. The survey was developed using Dillman`s tailored design method (Dillman, 2000). A total of 2,200 surveys were mailed to ran ‐ domly selected execu ti ves of small Slovenian firms in the manufacturing industry. All valid returned sur ‐ veys were then complemented with the financial data of the firms whose owners answered the sur ‐ vey. The final research sample consisted of 497 en ‐ trepreneurs. Each entrepreneur was associated with a firm for which we had financial data from balance sheets and income statements. Exploratory factor analysis and reliability anal ‐ ysis were performed in SPPS sta ti s ti cal so ft ware, whereas confirmatory factor analysis and tes ti ng of the proposed structural models were conducted with structural equa ti on modeling using EQS (Mul ‐ ti variate So ft ware) version 6.1. The ERLS method was used because a small amount of non ‐normality was found in the data. As recommended by several scholars (Breckler, 1990; Shook, Ketchen, Hult, & Kacmar, 2004), the fit of the model was assessed with mul ti ple indices. These indices were NFI, NNFI, CFI, GFI, SRMR, and RMSEA. Values of NFI, NNFI, CFI, and GFI higher than 0.90 indicate a good model fit (Byrne, 2006; Hair, Black, Babin, & Anderson, 2009), whereas values of SRMR lower than 0.08 in ‐ dicate an acceptable fit (Hu & Bentler, 1999). Fi ‐ nally, RMSEA values lower than 0.05 indicate a good fit, and values as high as 0.08 represent rea ‐ sonable errors of approxima ti on in the popula ti on (Hair et al., 2009). 3.2 Opera ti onaliza ti on and measure valida ti on Independent variables – the six inves ti gated firm characteris ti cs – were obtained from ques ti on ‐ naires and from firms’ financial statements. Legal status of the firm was measured with a dichoto ‐ 2.7 Debt maturity structure and innova ti on performance The direct rela ti onship between the debt ma ‐ turity structure of small firms and their innova ti on performance is s ti ll understudied. In this sec ti on, we review some relevant research results that will facilitate postula ti ng our last four research hy ‐ potheses. Serveral scholars have found that financing is posi ti vely related to small ‐firm growth (Beck, Demirguc ‐Kunt, & Maksimovic, 2005; Campello, 2006; Petersen & Rajan, 1997) and that innova ti on performance is related to growth (Anton či č, Pro ‐ dan, Hisrich, & Scarlat, 2007; Hult, Hurley, & Knight, 2004); thus it can be assumed that financing also is related to the innova ti on performance of small firms. Specifically, small firms that correctly align their financing mix to their R&D focus perform bet ‐ ter than their counterparts which are misaligned (Robb & Seamans, 2014). Moreover, some scholars (e.g. Brown, Fazzari, & Petersen, 2009; Delmas, 2002; Galia & Legros, 2004; Mendonca, 2004) found that lack of external financial sources, either short ‐term or long ‐term, hinders the innova ti on performance of firms. The radicalness of innova ti on ac ti vi ti es is also important when choosing whether or not to finance innova ti ons (Nanda & Rhodes ‐ Kropf, 2017). Based on these findings, the hypothe ‐ ses regarding maturity structure and innova ti on performance are postulated as follows: Hypothesis 7a: Short ‐term debt is posi ti vely related to innova ti on performance of small firms in terms of product innova ti ons. Hypothesis 7b: Short ‐term debt is posi ti vely related to innova ti on performance of small firms in terms of organiza ti onal modifica ti ons. Hypothesis 8a: Long ‐term debt is posi ti vely related to innova ti on performance of small firms in terms of product innova ti ons. Hypothesis 8b: Long ‐term debt is posi ti vely related to innova ti on performance of small firms in terms of organiza ti onal modifica ti ons. Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 9 an opportunity, we test a lot of di fferent ideas. The extent to which respondents agreed or disagreed with the statements was measured on a five ‐point Likert scale ranging from 1 (strongly disagree) to 5 (strongly agree). 4 RESULTS Results indicated that the proposed model of small ‐firm financing through short ‐term debt and long ‐term debt provided a good fit to the data (NFI = 0.91; NNFI = 0.92; CFI = 0.94; GFI = 0.91; SRMR = 0.07; and RMSEA = 0.06). Structural equa ti ons with standardized coe fficients are shown in Table 1. Ex ‐ amina ti on of the hypotheses related to the model of small ‐firm financing through short ‐term debt and long ‐term debt is presented in the following para ‐ graphs and summarized in Table 2. Hypothesis 1 looked at the rela ti onships be ‐ tween the legal status of the firm and short ‐term debt (H1a) and between the legal status of the firm and long ‐term debt (H1b). Empirical results were found to support Hypothesis 1a (a nega ti ve and sig ‐ nificant standardized coe fficient of −0.27) and Hy ‐ pothesis 1b (a nega ti ve and significant standardized coe fficient of −0.26). These results indicate that sole proprietorships received less short ‐term debt and long ‐term debt than did limited liability companies and incorporated firms in the sample. Hypothesis 2 proposed that firm age would be nega ti vely related to external financing in terms of short ‐term debt (H2a) and long ‐term debt (H2b), meaning that young firms borrow more on a short ‐ term basis and on a long ‐term basis than do older ones. Empirical results were not found in support of Hypotheses 2a and 2b. Hypothesis 3 inves ti gated the rela ti onship be ‐ tween a higher propor ti on of tangible assets to total assets and short ‐term debt (H3a) and long ‐term debt (H3b). Hypothesis 3b was supported, because the results indicated a significant posi ti ve rela ti on ‐ ship between the percentage of tangible assets in total assets and long ‐term debt (posi ti ve and signifi ‐ cant standardized coe fficients of +0.46). Hypothesis 3a was not supported (non ‐significant standardized coe fficient of +0.04). mous variable, where sole proprietorship received a value of 1, and other legal statuses, e.g., limited liability company received a value of 0. Firm age was measured with the number of years from the firm’s establishment. Tangibility of assets was measured by the percentage of tangible assets in total assets. Cash flow, the long ‐term financing of long ‐term as ‐ sets and inventories ra ti o, and the quick ra ti o were calculated using formulas from the Slovenian Ac ‐ coun ti ng Standards and the corresponding items from the firms’ balance sheets. The two dependent variables – short ‐term debt and long ‐term debt – were measured with corre ‐ sponding items from firms’ balance sheets. Organiza ti onal modifica ti on and product inno ‐ va ti ons were presented in the model as latent vari ‐ ables, which were measured by mul ti ple indicators. Organiza ti onal modifica ti ons were measured with three items. Respondents were asked to rate the ex ‐ tent to which they agreed with the following state ‐ ments: (1) Our company abandoned non ‐profit business in the last three years; (2) Our company set up new businesses in the last three years; and (3) Our company invested seed funds in the ini ti al en ‐ trepreneurial ac ti vi ti es in the last three years. The extent to which respondents agreed or disagreed with the statements was measured on a five ‐point Likert scale ranging from 1 (strongly disagree) to 5 (strongly agree). Product innova ti ons were measured with seven items. Respondents were asked to rate the extent to which they agreed with the following statements: (1) In the past three years our company has ob ‐ tained a greater number of patents than our main compe ti tors; (2) In the past three years our com ‐ pany has ini ti ated on the market a large number of new products or services (more than the average in the industry); (3) In the past three years our com ‐ pany has invested in research and development a large amount of funds (more than the average in the industry); (4) In the past three years our company has invested more funds in the development of new products or services than our compe ti tors; (5) Our company has found new niches in exis ti ng markets in the past three years; (6) In the past three years our company has led the development of key inno ‐ va ti ons in the industry; and (7) In order to recognize Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 Alenka Slavec Gomezel: Firm Characteris ti cs, Debt Maturity Structure, and Innova ti on Performance of Small Firms 10 The results supported Hypothesis 4, which looked at the rela ti onships between cash flow and short ‐term debt (H4a) and long ‐term debt (H4b). As indicated in Table 1, cash flow was nega ti vely and significantly related to long ‐term debt (stan ‐ dardized coe fficient of −0.09) and only par ti ally re ‐ lated to short ‐term debt (standardized coe fficient of −0.08 which was sta ti s ti cally significant only at the 10% level). The results showed sta ti s ti cally significant sup ‐ port for Hypothesis 5a, which looked at the rela ti on ‐ ship between the long ‐term financing of long ‐term assets and inventories ra ti o and short ‐term debt (a nega ti ve standardized coe fficient of −0.16), but no support was found for Hypothesis 5b, which looked at the rela ti onship between the long ‐term financing of long ‐term assets and inventories ra ti o and long ‐ term debt. Hypothesis 6 looked at the rela ti onships be ‐ tween the quick ra ti o and short ‐term debt (H6a) and between the quick ra ti o and long ‐term debt (H6b). Empirical results supported Hypothesis 6a (a nega ‐ ti ve and significant standardized coe fficient of −0.19) and Hypothesis 6b (a nega ti ve and significant standardized coe fficient of −0.10). The last four hypotheses examined the rela ti on ‐ ships between debt maturity (short ‐term debt and long ‐term debt) and innova ti on performance of small firms. As indicated in Table 1, short ‐term debt was strongly, posi ti vely, and significantly related to the in ‐ nova ti on performance of small firms in terms of prod ‐ uct innova ti ons (H7a, standardized coe fficient of +0.23) and organiza ti onal modifica ti ons (H7b, stan ‐ dardized coe fficient of +0.30). Finally, the results of the study indicated that the associa ti on between long ‐ term debt and innova ti on performance of small firms in terms of product innova ti ons and organiza ti onal modifica ti ons is sta ti s ti cally significant and posi ti ve only at the 10% level (H8a, standardized coe fficient of +0.11; and H8b, standardized coe fficient of +0.11). 5 DISCUSSION AND CONCLUSION Small firms face constraints in obtaining exter ‐ nal financial sources. Thus, understanding which and how a firm’s characteris ti cs are related to small ‐ firm financing decisions and the availability of ex ‐ ternal financial sources for small firms has led us to an in ‐depth analysis of the rela ti onship between six firm characteris ti cs and the maturity structure of Independent variables Dependent variables Short ‐term debt Long ‐term debt Product innova ti ons Organiza ti onal modifica ti ons Legal status (sole proprietorship) −0.27* −0.26* Firm age +0.05 −0.04 Tangibility of assets −0.04 +0.46* Cash flow −0.08# −0.09* Long ‐term financing of long ‐term assets and inventories ra ti o −0.16* +0.06 Quick ra ti o −0.19* −0.10* Short ‐term debt 0.23* 0.30* Long ‐term debt 0.11# 0.11# Error 0.92 0.88 0.95 0.93 R‐squared 0.16 0.23 0.09 0.13 Note: * denotes Sig. < 0.05; # denotes Sig. < 0.10. Table 1: Structural equa ti ons for the model of small ‐firm financing through short ‐term debt and long ‐term debt Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 11 debt used by small firms. Specifically, we analyzed the rela ti onship between the legal status of the firm, firm age, tangibility of assets, cash flow, long ‐ term financing of long ‐term assets and inventories ra ti o, and the quick ra ti o and short ‐term debt and long ‐term debt. Moreover, we also analyzed the re ‐ la ti onship between short ‐term debt and long ‐term debt and innova ti on performance in terms of prod ‐ uct innova ti ons and organiza ti onal modifica ti ons. Un ti l now, some of these rela ti onships had not been inves ti gated. Therefore, there are several important observa ti ons regarding the results of our study. Table 2: Results of hypotheses tes ti ng for the model of small ‐firm financing through short ‐term debt and long ‐term debt Hypothesis Independent variable Predicted rela ti onship Dependent variable Result H1a Legal status (sole proprietorship) − Short ‐term debt ✓ ❏ H1b − Long ‐term debt ✓ ❏ H2a Firm age − Short ‐term debt ✕ ❏ H2b − Long ‐term debt ✕ ❏ H3a Tangibility of assets − Short ‐term debt ✕ ❏ H3b + Long ‐term debt ✓ ❏ H4a Cash flow − Short ‐term debt ✓ ❏ * H4b − Long ‐term debt ✓ ❏ H5a Long ‐term financing of long ‐term assets and inventories ra ti o − Short ‐term debt ✓ ❏ H5b − Long ‐term debt ✕ ❏ H6a Quick ra ti o − Short ‐term debt ✓ ❏ H6b − Long ‐term debt ✓ ❏ H7a Short ‐term debt + Product innova ti ons ✓ ❏ H7b + Organiza ti onal modifica ti ons ✓ ❏ H8a Long ‐term debt + Product innova ti ons ✓ ❏ * H8b + Organiza ti onal modifica ti ons ✓ ❏ * Legend: ✓ ❏ The hypothesis was confirmed at 5% significance. ✓ ❏ * The hypothesis was confirmed at 10% significance. ✕ ❏ The hypotheses was rejected. Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 Alenka Slavec Gomezel: Firm Characteris ti cs, Debt Maturity Structure, and Innova ti on Performance of Small Firms 12 The firm characteris ti c with the highest regres ‐ sion coe fficient significantly related to maturity of debt was the tangibility of assets. Although it was posi ti vely related only to long ‐term debt, the result is not surprising because short ‐term debt is less o ft en secured with collateral. This result implies that firms seeking long ‐term debt should have enough tangible assets in the form of land, factories, ma ‐ chines, and equipment. The results of the study also suggest that the legal status of the firm ma tt ers when applying for short ‐term and long ‐term debt. Lenders prefer fi ‐ nancing firms with the legal status of an en ti ty rather than sole proprietorships. This builds trust in the dy ‐ namic rela ti onship between lenders and firms. Thus, we suggest that firms transform their legal status from sole proprietorships to limited liability compa ‐ nies if the benefits of being a limited liability com ‐ pany, other than an easier way to obtain external financing, prevail over the benefits of being a sole proprietorship. Advantages and disadvantages of sole proprietorships and limited liability companies were extensively discussed in the paper. Another sugges ti on for sole proprietorships is to also estab ‐ lish a limited liability company and gradually transfer business opera ti ons from the sole proprietorship to the limited liability company. This will eventually fa ‐ cilitate gaining external financial sources, new part ‐ ners, and new business because the credibility and soundness of the business will increase. An addi ti onal contribu ti on of this research is the inves ti ga ti on of the rela ti onship between cash flow and short ‐term and long ‐term debt, because these rela ti onships have not been the center of a tt en ti on of previous research. The results suggest that small firms with substan ti al internally generated funds do not have to rely on external financial sources. Own financial funds are less expensive and are not bind ‐ ing for a company because credit approved by exter ‐ nal lenders has to be repaid at given deadlines and amounts. These results are consistent with results of scholars who dealt with the rela ti onship between profitability and external financial sources. Those scholars found a nega ti ve rela ti onship between prof ‐ itability and external financial sources because firms generate enough funds internally (Chi tt enden et al., 1996; Hall et al., 2004; Jordan, Lowe, & Taylor, 1998; Van der Wijst & Thurik, 1993). Another interes ti ng result arose from the inves ‐ ti ga ti on of the rela ti onship between two ra ti os – the long ‐term financing of long ‐term assets and inven ‐ tories ra ti o and the quick ra ti o – and short ‐term debt and long ‐term debt. These two ra ti os cover all items in a balance sheet – the long ‐term financing of long ‐term assets and inventories ra ti o captures long ‐term assets and long ‐term liabili ti es, and short ‐ term inventories, whereas the quick ra ti o captures all short ‐term assets without inventories and short ‐ term liabili ti es. The long ‐term financing of long ‐ term assets and inventories ra ti o was related only to short ‐term debt. This rela ti onship was nega ti ve as predicted, which is ra ti onal because the ra ti o ex ‐ cludes short ‐term financial sources and is nega ti vely related to them. Moreover, in an extreme case a firm may finance all assets, including short ‐term as ‐ sets, with long ‐term liabili ti es. Interes ti ngly, the quick ra ti o was nega ti vely and significantly related to both short ‐term debt and long ‐term debt, which was also a predicted rela ti onship. In an extreme and only theore ti cal case, a firm may finance all its as ‐ sets, including long ‐term assets, with short ‐term li ‐ abili ti es. However, a tt en ti on is needed when dealing with financial ra ti os because it is important to accu ‐ rately understand and correctly interpret each ra ti o and appropriately make use of them (e.g., Abdel ‐ Khalik, 1973; Zimmer, 1980). Finally, an important contribu ti on to the en ‐ trepreneurial and financing literature is the inves ti ‐ ga ti on of the rela ti onship between short ‐term and long ‐term debt and innova ti on performance of small firms. The results of the present study con ‐ firmed our assump ti on of the posi ti ve rela ti onship between external financial sources and innova ti on performance of small firms in terms of product in ‐ nova ti ons and organiza ti onal modifica ti ons. For their innova ti on ac ti vi ti es, firms need addi ti onal fi ‐ nancial sources because engaging in innova ti on ac ‐ ti vi ti es require substan ti al funds. Thus, it is recommended that external financial sources are more a ffordable for smaller firms. To conclude, we emphasize the importance of building long ‐term and honest rela ti onships be ‐ tween lenders and firms, because this brings trust and commitment and might make financial re ‐ sources more a ffordable and firms more able to in ‐ novate. Dynamic Rela ti onships Management Journal, Vol. 11, No. 1, May 2022 13 REFERENCES Aaronson, D., Bos ti c, R. W ., Huck, P ., & T ownsend, R. (2004). Supplier rela ti onships and small business use of trade credit. 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