J. Service Science & Management, 2009, 2: 378-383 doi:10.4236/jssm.2009.24045 Published Online December 2009 (www.SciRP.org/journal/jssm) Copyright © 2009 SciRes JSSM Informal Financing of Small – Medium Enterprise Sector: The Case of Greece Panagiotis Petrakis 1,* , Konstantinos Eleftheriou 2 1 Department of Economics, University of Athens, Stadiou Street, Athens, Greece; 2 Department of Economics, University of Piraeus, Karaoli & Dimitriou Street, Piraeus, Greece. Email: ppetrak@econ.uoa.gr, kostasel@otenet.gr Received July 17, 2009; revised August 23, 2009; accepted September 29, 2009. ABSTRACT In this paper, we attempt to find a “channel” through which Greek economy can exhibit a relative “resistance” in a credit crunch. For this purpose, we specify an error correction model so as to test the relationship between corpo- rate bank loans and commercial papers comprised of post-dated cheques and bills of exchange. The results show that corporate bank loans and cheques - bills of exchange are substitutes. This finding combined with the fact that in Greece, the issuance of these papers is positively connected with the informal economic activity which in turn rises dur- ing economic downturns, has a strong economic implication regarding the ability of Greek economy to partly “amor- tize” the shocks connected with the current financial crisis. Keywords: Corporate Finance, Credit Crunch, Shadow Financing 1. Introduction Is there an interrelation between bank loans and commer- cial papers (cheques, bills of exchange) as a source of ex- ternal debt financing for firms in Greek economy, and if yes, are they substitutes or complements? Which is the economic intuition between such an interrelation and can it offer a safety net to the current credit crunch? These are the main crucial questions we try to answer in this paper. One of the main factors which determine the level of “resistency” of an economy in a bank credit crunch is the ability of the economic system to create multiple “chan- nels” of financing and exploit them properly. In modern economies, firms have a variety of debt financing tools at their disposal. However, each of these tools has a different rank in firm’s preferences. According to the traditional “pecking order” hypothesis of corporate finance [1], bor- rowing firms prefer to finance their debts through external resources (securities, bank loans) rather than equity issu- ance. Equity issuance is less preferred since the funds it provides are generally limited by the scale of expenditures (dividends) and it is considered by investors, as a “bad” signal for the economic performance and viability of the firm. Hence, firms mainly choose between bank borrowing and debt securities issuance, when it comes to finance their corporate expenditures. Greenspan [2,3], emphasized the importance of such a choice under a credit crisis re- gime. More specifically, he suggested that there is a rate of substitutionality between the market of bank loans and that of bonds which smoothes the negative impact that a finan- cial crisis has on real economy. On the other hand, Holm- strom and Tirole [4], stressed that “multiple avenues of intermediation” (availability of the aforementioned sources of external debt financing) for corporations are character- ized by complementarity. Their analysis is based on a principal-agent problem with monitoring costs. When the supply of intermediary capital falls due to a credit crunch, the quantity of informed (banks) finance which is available to firms decreases. This also means that less uninformed (securities) finance can be attracted since the level of moni- toring undertaken is lower 1 . The findings of Holmstrom and Tirole [4], were empirically verified for U.S. economy by Davis and Ioannidis [5]. Gertler and Gilchrist [6], argued that the salutary effects stemming from the substitutionality between the main al- ternative “channels” of corporate debt financing are limited when the market is dominated by small firms. This occurs, since large firms have access to short-term sources of redit (e.g. commercial papers market) unavailable to * This paper is based on an ongoing research project titled: “Economic Growth and Development in the Greek Economy”. We would like to thank an anonymous referee for useful comments and suggestions. Any remaining errors are ours. 1 Uninformed investors are less willing to offer their funds when the level of monitoring connected with the informed finance is low. c