Financial literacy, financial development, and leverage of small firms

Abstract

This study examines the relationship between financial literacy and the leverage of small firms, specifically of the legal forms, sole proprietorships, and partnerships. Using a cross-section of 73,302 firms in 22 countries, we find that the leverage of small firms is negatively associated with financial literacy. Further, we explore the role of financial development, bankruptcy and transaction costs, and information asymmetry, in moderating the relationship. We find that the negative relationship is less pronounced in countries with lower financial development, high bankruptcy and transaction costs, and high information asymmetry environments, respectively. We contribute to the understanding of small firms' leverage and the literature on financial literacy, SMEs, finance, and entrepreneurship. This study offers policy implications for economies that promote SMEs for entrepreneurship training and development.