unique challenges faced by SMEs accessing external finance: small firms in countries with strong creditor protection are more likely to receive external financing compared to comparable firms that are located in weak legal environments.

# **_SMEs in Eastern Europe_**

Looking more closely at SMEs in Eastern European countries, we find a growing body of literature studying financial characteristics and capital structure determinants, either within a cross-sectional setting or in the form of a country-specific analysis.

Among the first group, we find studies that broadly examine financial market development across Eastern Europe. For instance, Gros and Suhrchke (2000) analyze several transition economies and identify the chief similarities and differences across them in terms of the level of financial development, concentration of ownership, and legal and governance standards. A study by the World Bank (2002) examines the early stages of reform and transition to market economy performed by the corporate sector. In particular, it highlights the dynamism of the SME sector in Poland and Hungary, where structural reforms have created a favorable climate for entry of new businesses.

Other studies focus on property rights as a determinant of access to financing for small firms in Eastern Europe. Shleifer (1997) and Frye and Shleifer (1997) show, for instance, that property rights are particularly weak and a severe disincentive to growth in Russia, while this is not the case for Poland, which has relatively more secure property rights than other countries in the region.<sup>3</sup> Johnson, McMillan and Woodruff (2002) study manufacturing firms in Poland, Romania, Slovakia, Ukraine and Russia based on a survey carried out in 1997. They find a wide degree of variation across these countries in their access to bank finance as well as in their perceived security of property rights. The authors find the highest percentage of borrowers to be in Poland, with bank financing about 2.3% of annual sales (the highest along with Russia within their sample of countries). They also find a high rate of reinvestment of profits in Poland, which they explain is a virtue of strong property rights in the country, relative to neighboring economies.

Additional studies, which more directly analyze the determinants of capital structure, find a significant degree of financing constraints faced by SMEs.<sup>4</sup> The supply of finance seems to be particularly determined by firms’ reputation, growth and profitability. Closely related to our study is a paper by Klapper, Sarria-Allende, and Sulla (2002) who use the Amadeus database to analyze patterns of corporate sector development across 15 Eastern and Central European countries during the transition from planned to market economies. This report finds that SMEs seem to constitute the most dynamic sector of the Eastern European economies, relative to large firms. In general, the SME sector comprises

> 3 It is argued that within country variation in property rights can also exist, influencing access to bank credit (Johnson, McMillan and Woodruff, 2002)

> 4 Konings, Rizov and Vandenbussche (2003) find that investment by firms in Poland and Czech Republic is more sensitive to internal financing constraints, as compared to the Romania and Bulgaria case, due to presence of soft budget constraints in the latter. In the same vain, Cornelli et. al. (1996) and Weller (1999) observe that Polish industries have operated under hard budget constraints and were finance constrained during the early stages of the transition process.

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