Retention rate, dept-equity, and return on assets: a theoretical risk reconciliation for small firm growth

Abstract

There has been relatively little research into the financing and growth rates of small firms
even though they are the main vehicle for a nation's economic growth. This paper examines the
relationship among retention rate, debt-equity ratio and return on assets for the small firm. The study
demonstrates, through a simplified model, that the lack of an active equity market can be responsible for
limitations in the size of the small firm. The model further demonstrates that if only internal financing is
utilized a severe constraint is placed on the actual rate of growth of the firm. A combination of internal
equity financing and external debt financing produces a higher (though still constrained) growth rate.