Finance Theory and Small Enterprise

Abstract

This chapter explores the major features and principles of traditional finance theory and considers their usefulness as theoretical underpinnings for small enterprise financial management. It commences with a review of the assumptions of traditional finance theory and the likely changes when the underlying assumptions are relaxed and the many imperfections of the real world are admitted. Incorporated is a discussion of how factors formerly considered anomalies associated with small enterprises are being admitted into traditional finance theory. Particular emphasis is given to identifying features that differentiate small firms from large firms and to the range of common circumstances that small enterprises share. Attention is then turned to an important area where small enterprises differences appear to be significant and to challenge the precepts of traditional theory. This is the area of determining cost of capital by relying on the 'capital asset pricing model (CAPM)'. Included is discussion of the evidence that casts doubt on the usefulness of the CAPM and assessment of various modifications to the CAPM that may enhance understandings of the risk-return relationship in small firms. The chapter concludes with a discussion of emerging alternatives to traditional finance theory and considers their possible role in understanding and improving financial management in small enterprises.