SMEs' behavior under financial constraints: an empirical investigation on the legal environment and the substitution effect with tax arrears

Considering the Italian legal environment, this work aims to shed new light on the behavior ofSMEs under financial constraints, investigating how the inefficiency of courts in enforcing creditrights can affect their corporate finance. On the one hand, our results confirm previous findingson the pecking order theory, supporting the hypothesis of substitution between financial debtsand trade credits. On the other hand, based on our evidence, if SMEs are affected by judicialinefficiency, we can expect their access to both the capital market and trade credit to be limitedby the uncertainty of the legal environment, causing them to use tax arrears to raise internalliquidity. Indeed, if the time needed to settle insolvency cases decreases by 20%, we can expect anincrease in the financial debt ratio between 1.07% and 3.87% and in the trade credit ratio be-tween 0.14% and 1.35%, while, focusing on tax arrears, we can expect a decrease in the tax debtratio between 0.78% and 1.61%