CHAPTER 2

LITERATURE REVIEW
2.1 Conceptual Classification
There are diverse views on the concept of SMEs (Bamidele, 2012). However, one clear
point is that the conceptualization of SMEs is country-specific. SMEDAN (2017) defined
SMEs based on the following criteria: small scale enterprises are businesses with ten to
forty-nine people with an annual turnover of five to forty-nine million naira, while a
medium scale enterprise has fifty to one hundred and ninety-nine employees with a
yearly turnover of fifty to four hundred and ninety-nine million Naira (Ikon and Chukwu,
2018).

Akingunola (2011), Wendrell (2003), Abiodun (2014), Adefeso (1998), Adoyi and Agbo
(2009) have examined the SMEs from vantage of the challenges confronting them.
These are grouped under the managerial, financial, marketing, infrastructural logistics,
and inadequate information. The scholars dwell extensively on the challenges but while
some would avoid suggested solutions like a plague, the recommendations of others
are unrealistic and beyond reach. A few much more realistic approach has to take into
cognizance that Nigerian SMEs are operating in a dependent neo-capitalist economy
with peculiar characteristics and challenges.

Extant literature has revealed that the performance of SMEs in Nigeria is relatively low
(Gbandi & Amissah, 2014; Abaukaka, 2014). Regardless of the importance of the SMEs,
their contribution to gross domestic product (GDP) is 10% which is at low ebb. It has
been observed that more than 90% of SMEs exist in Nigeria but its low contribution to
GDP negates the attendant roles to economic growth. Various factors account for the
low contribution of the SMEs to Nigeria’s GDP; unfriendly business environment, poor
funding, low management skills, and lack of access to modern technology (Gbandi &
Amissah, 2014).
Despite the low performance of SMEs which is attributed to socio-economic and
political factors, SMEs in Nigeria constitute the most feasible instrument for self-
sustaining industrial development (Duru & Kehinde, 2012). Its ability to instill the zeal of
the culture of an indigenous enterprise is a catalyst for industrialization and
technological advancement. Its continual ideals to expand frontiers of expansion
engenders innovation and marketing drives which translate to profitability, economic
prosperity, per capita income increase, and employment generation. SMEs serve as a
catalyst for employment generation, national growth, poverty reduction, and economic
development. SMEs the world over can boast of being the major employers of labour if
compared to the major industries including the multinationals (Imoughele & Ismaila).

Similarly, every scholar confronts the challenge of definition and categorization.

However, there exists a high level of consensus on the importance of SMEs, as a sub
sector to the economy. Oluba (2009), Adelaja (2003), Ahmed (2006), Oppong (2014)
have however observed that the importance of SMEs varies with sectors and with the
developmental stage of a country. They were of the view that developing economy
characteristics such as the level of capital allocation/requirements, management
size/arrangements as well as the limited market access, make SMEs less amendable to
the disappointing results of development strategies. This is because the focus is on
large capital intensive and high import dependent industrial plants. Nevertheless, there
is no level of economic development that does not require the service of the SMEs.
Even the developed economy cannot afford to do without SMEs.

SMEs Description
SMEs are believed to be the engine room for the development of any economy because
they form the bulk of business activities in a growing economy like Nigeria. Employment
generation contributed to global GDP and SMEs play a critical role as the principal
safety net for the bulk of the population in developing economies. Their labor intensity
structure accounts for their recognition as a job-creating avenue. SMEs constitute major
avenues for income generation and participation in economic activities in the lower-
income and rural brackets of developing societies, especially in agriculture, trading, and
services. The employment opportunities provided reduce rural urban migration and
allows for even development. National economic development prospects hinge on the
entrepreneurial energy of vibrant SMEs as most big business concerns grew from small
scale to become big icons. SMEs protect nations from geographical cost-benefit
permutations of a few multinationals who are ever prepared to close up their
businesses at the slightest provocation or appearance of economic downturn. Many
economies developed and developing have come to realize the value of small
businesses. Small business seems to be characterized by dynamism, witty innovations,
efficiency, and their small size allows for a faster decision making process. The benefits
of SMEs cannot be overemphasized they include; contributions to the economy in terms
of output of goods and services, creation of jobs at relatively low capital cost, especially
in the fast growing service sector. It is a vehicle for the reduction of income disparities
thus developing a pool of skilled or semi-skilled workers as a basis for future industrial
expansion; improve forward and backward linkages between economically.

Furthermore, the position of Olise (2000), Olatunji (2002), Opafunso and Adepoju (2014)
is that SMEs spring up as a result of the evolution of entrepreneurship. In other words,
the so called big or large scale industries started as a small scale business organization
before growing into an octopus or corporate behemoth. Their works however did not
dwell much on why some SMEs would thrive and others fail. Also, the concern of
Safiriyu and Njogo (2012); Akingunola, (2011) is on the financing option available to
SMEs. They listed the sources as personal savings, borrowing, debenture, selling of
shares, leasing, hire purchase, trade credit, foreign investors, home equity – financing
accounts payable just to mention few. While reiterating the difficulties in accessing the
fund, not quite much was discussed as to why the sources that were available were not
judiciously utilized.

2.1.1 Business environment:

Business activities thrive in a conducive and sustainable environment. Conducive and
sustainable environment depends on the availability of infrastructure put in place by the
government. Nigeria’s business environment in the recent years has been characterized
by uncertainty leading to collapse of some business outfits particularly, the small and
medium scale business and the relocation of the big ones to other countries (Ogunro,
2014).

According to Orisewezie (2010), business environment is an important determinant for

economic growth, poverty reduction, sustainable development and attainment of the
Sustainable Development Goals (SDG’s). Business environment indeed, entails
providing enabling conditions for effective, efficient and profitable enterprise
development and it is the primary responsibility of governments at all levels to provide
such conducive environment, though there are some business environmental factors
that are outside the control of the government. Indeed, the quality of business
environment is directly linked to the quality of governance. A good business
environment involves well-functioning and efficient public infrastructure, institutional
systems and regulatory services. It helps to reduce the cost of doing business,
difficulties encountered in operating a business and business mortality rate. On the
other hand, bad business environment adversely affect individuals, businesses and
communities. It increases poverty and reduces the nation’s global economic
competitiveness.

The nature of business environment are said to be classified as dynamic, stable and
unstable which often help a firm in the selection of appropriate strategies (Ibidun &
Ogundele, 2013). Adeoye (2012) opined that in order for business to cope with the
dynamic and rapidly changing business environment, there is a need to develop and
implement appropriate strategies that would safeguard their operations and yield the
desired results. Similarly, Ibidun and Ogundele, (2013) added that a firm’s perception of
the nature of the business environment is a function of its size and industry.

Business environment can be broadly categorized into internal and external

environment with the former comprising variables or factors within the control and
manipulation of the firm to attain set objective while the latter encompasses factors
that are outside the control and manipulation of the firm. Hence, firm must develop a
plan that will help it to cope with the various environmental forces.

2.1.2 Nigeria’s Business Environment: An Overview:

Nigeria is made up of over 180 million inhabitants with different ethnic groups
numbering about 234. There are also 36 states and 774 local governments in Nigeria
with Abuja as the federal capital. Lagos is the commercial nerve center of the country
and it is considered a ‘mini Nigeria’ because of its large mixed population. Other state
capitals also play huge role in contributing to the Nation’s GDP. However, adequate
infrastructural facilities which serve as a hallmark of large cities are still missing in
most of these cities. Nigeria is endowed with abundance of mineral and human
resources, which should have enhanced the country’s position in the comity of nations.
However, despite the abundant resources, the country is still being confronted by a lot
of socio-economic and political challenge. This has affected the economic growth and
development of the nation.

A good business environment is always determined by the ease with which businesses
can be done successfully. Many studies have categorized the Nigerian business
environment as harsh. According to the World Bank Annual Business report of 2014, the
Nigerian business environment is ‘deteriorating’. This opinion is the outcome of an
assessment of four critical business activities, which are: Starting a business,
registering a property, getting construction permits and enforcing contracts. According
to the World Bank, Nigeria dropped from 138th position in 2013 to 147th position in
2014, although, for 2015 Nigeria is ranked 135th, which is a positive improvement, but a
far cry. This shows that the business environment is still struggling to improve. Obiwuru,
Oluwalaiye and Okwu (2011) put forward several other factors such as technology, legal,
political and economic, which also affect the business environment in Nigeria.

2.2 Theoretical Review

The theory underpinning this study is the three Sigma’s Theory. This theory is an
application of Peter Drucker theory of business. The theory has three divisions:

First division: Is organizational focus, which postulates that strategic thinking starts by
reassessing organization’s mission, vision, and purpose, and the examination of these
components for reliability to spot inherent and precise suppositions that have an effect
on decision on whether to enter or remain in the business enterprise activity (Ezenwa,
2016).

Second division: This theory has to do with the external environment and contains five
components. The first component require the enterprise to analyze the social, economic,
and political factors in the external business environment to establish the precise
suppositions regarding the major factor that influence the firm’s decisions, and its
activities. The second component emphases market factors such as existing and
potential customers, distribution channel, advertisement, promotion, pricing, product
distinctiveness, among others, which require strategic thinking to ascertain the relevant
deductions. The third component of this division reflects on the users of the enterprise
product, and calls for the firm to evaluate the factors of its customer behavior, which
include the firm’s product purchase decision, influences on the purchase or use of the
product and so on, to find out the customers characteristics that influence the decision
and expectations of the business organization. The fourth component require the firm
to study the technological factors of the business environment to find out the causal
features of the technological environmental factors that influence the firm’s decisions
and expectations. Lastly, the fifth component dwells on the industry competitive
formation and necessitates the need for the business organization to examine this
formation to determine the features of competitive formation that influence the
business decisions. This structure includes the potential new entrants into the market,
suppliers, substitute products, market segment product, and major competitors. These
competitive industry factors which pose the greatest threat that must be neutralized by
taking strategic steps (Adeeko, 2017).

Third division: This business model is rooted on the competitive advantage and core
competencies of a firm. It stressed the need for a firm to examine organizational
competencies. The second division of the business model provides a theoretical base
for this study as it shows that business environmental factors necessitate the need for
a business enterprise to operate strategically in order to survive and boost
effectiveness in their performance in a most efficient manner. This theory is highly
relevant in explaining how the environment impact businesses.

2.3 Empirical Review

As it was mentioned in the previous chapter, SMEs decisions towards the choice of long term
and short term debt is different, due to their borrowing attitudes. Therefore, the result of this
empirical research will be represented in the different debt categories. The analysis will be
carried out to find out the difference between the effect of short term leveraging on ease of doing
business among SMEs in ogbomoso north. Coefficient (β) and ρ-value are used in order to
interpret the results of the regression model. Two regression models are design, one with short
term debt as dependent variable and the other one with long term debt as dependent variable.
Accordingly, two separate tables describe the statistical findings of the data. It is necessary to
mention that as this thesis use the sample of almost 10 firms over a year. The most appropriate
method of analysis for this research is panel data random effect analysis, which will be carried
out by using SPSS software.

2.4 Gap in Literature

Small and medium Enterprises (SMEs) are, by definition, characterized by small size

(Eze, Worimegbe &Kolawole, 2016). This smallness affects the firm’s positioning on

factor, product, financial, and personnelmarkets in terms of bargaining power, name

recognition, and brand awareness. According to Eze,Oladimeji & Fayose (2018), SMEs

can be segregated into three main sectors such as general business manufacturing and

agriculture. SMEs are diverse in nature and can be established for any kind of business

activities in urban or rural area. It can be considered as a back bone of national

economy. SMEs can be defined in terms of sales volume, number of employees, or

investment (Ajide, Hameed, &Oyetade, 2014). A business that is therefore defined as a

small or medium enterprise in a developed country can be regarded as a large

enterprise in a developing country. Even in developing countries, this definition changes

over time. The European Commission defines SME using three broad parameters: micro

-entities, small companies, and medium-sized enterprises (Ifekwem & Adedamola,

2016).According to Quartey, Turkson, Abor & Iddrisu (2017), the SMEs sector in West

Africa is a mixture of self-employment outlets and dynamic enterprises that are involved
in an array of activities mainly concentrated in urban areas. In the Nigerian context,

Small enterprises are business entities that have between ten to forty nine employees

with asset (excluding land and building) of between five million naira and less than fifty

million naira while medium enterprises are business enterprise with staff strength of

between fifty and one hundred and ninety nine employees and asset (excluding land and

building) of between fifty million and less than five hundred million naira (SMEDAN,

2007).

2.5 Conceptual Framework

Since Modigliani and Miller theorem forty years ago, number of leverage relevance

theories has been advanced by amendment of the perfect capital market assumptions

of the original MM theorem. The theory of capital structure can be classified into three

groups: tax based theories; agency cost theories; asymmetric information and signaling

theories (Michaelas et al., 1999). This part aims to give a brief explanation about the

capital structure, and then present the capital structure theories, which is related to this

field of research.

The firm value can be seen as the discounted stream of expected cash flows generated

by its assets. Investors finance the firm’s assets, and they hold various sorts of claims

on the firm's cash flows. Debt holders’ claim on the firm’s stream of cash flows is safe

due to the contractual guarantees of a fixed schedule of payments. The claim of equity

holders on the residual stream of cash flows is more risky, since there is no payment

guarantee on equity. The combination of debt funds and equity funds (leverage) raise by the firm
defines its capital structure. By considering various constraints within the firm,
each firm tries to issue the particular combination of debt and equity to maximize its

overall market value.

Capital structures explained how projects and plans are financed. The proportion of

capital structure varies for each company. In fact, capital structure proportion

determines how the profit should be divided between creditors and the company’s

owners. According to Ross, Westerfield and Jordan (2008), if all the assets divided into

equity and debt, then the capital structure can be figured as a pie. The following figure is

also helpful in explaining other concepts in capital structure like leverage and debt ratio.

40%

60%

A=Total Asset
A=D+E B=Total Debt
E=Total Equity
The ratio below shows the proportion of a firm’s assets which are financed through

debt. The ratio is called debt ratio, and if it becomes less than one then most of the

firm’s assets are financed by equity. If the debt ratio becomes greater than one, then

most of the firm's assets are financed by debt. “Highly leveraged” term is given to the

firms with the high debt/asset ratio.

Debt Ratio= Total debt
Total equity

A firm’s financial leverage is calculated by dividing total debt by total equity. A high

debt/equity ratio means that a firm is aggressive in financing its growth with debt.

Highly levered firms are more vulnerable to downturns in their business cycles, due to
their legally binding payments.
Leverage = Total debt
Total equity

Deciding about the proportion of capital structure is one of the major concerns for

company’s director, since it is a tradeoff between risks and costs (Ross et al. 2008).

Issuing equity is expensive in compare to debt which is less expensive; however, debt

generates higher risk than equity. Therefore, the principal issue in capital structure

composition is to find the best proportion between debt and equity (Modigliani & Miller,

1958).

The best combination of equity and debt is the one that minimize the cost of capital,
and in return maximize the value of the firms. This combination of debt and equity is
called optimal capital structure. According to Modigliani and Miller (1963),
enhancement in leverage would generate the interest tax shield, which increases the
value for the company. However, an increase in debt level will increase the financial
distress cost, and the result is a decrease in the value of the company. According to
Bradley, Jarrell and Kim (1984), the optimal capital structure is the level of leverage,
which gives the best balance between the tax benefit and distress cost.