Robust SME investment and financing under market frictions

Lianfen Wang, Yao Wang, Hai Zhang and Shunming Zhang

Quantitative Finance, 2025, vol. 25, issue 11, 1831-1849

Abstract: This paper develops a real option model of robust SME investment to investigate the SMEs' heterogeneous investment and financing strategies under market frictions. When financing its project using the innovative credit guarantee scheme (Equity-for-guarantee swap, i.e. EGS) under asymmetric information, the high-type firm (with a high scale of the cash flow) can avoid underpricing its value by accelerating investment and distinguishing itself from low-type firms. However, we demonstrate that with model uncertainty, cash flow ambiguity amplifies investment distortion costs, making this signaling strategy ineffective. These effects derive debt financing without guarantee dominating EGS when market belief is significantly lower and it is more pronounced under relaxed financing constraints. We reveal the different effects of ambiguity and risk on financing decisions. Ambiguity affects financing decisions monotonically, while risk impacts are non-monotonic, which is determined by the degree of equity dilution using guarantee.

Date: 2025
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DOI: 10.1080/14697688.2025.2519842

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