Beyond the balance sheet: SME financing strategies for fixed assets amid constraints

This study examines how financial constraints influence the composition of financing used by small and medium-sized enterprises (SMEs) for fixed asset investment. Drawing on enterprise survey data from 42,929 SMEs across 121 countries between 2007 and 2024, we examine whether constrained enterprises rely more on internal or external sources to finance fixed asset investments. We find that SMEs reporting financing obstacles are significantly more likely to rely on external sources – such as equity, bank loans, non-bank institutions, trade credit, and informal sources like family and money lenders – to finance fixed asset investments. At the same time, the proportion of investment financed by internal funds declines as financial constraints intensify, suggesting a reallocation of internal liquidity toward short-term operational needs. Our findings remain consistent across regional, legal, and sectoral subgroups and are validated through alternative specifications, definitions of financial constraint, endogeneity-adjusted estimations, and pass falsification tests. These findings challenge the traditional pecking order expectation that constrained enterprises tend to prioritize internal funding, instead highlighting the role of collateralizability and credit rationing in shaping financing decisions. Our results imply that expanding access to diverse, collateral-friendly, and relationship-based financing instruments may be more effective in supporting SME capital investment than focusing solely on liquidity provision.