The Role of Informal Finance in Small Firm Capital Structure Decisions in Nigeria: Theory and Evidence

Informal finance, encompassing rotating savings and credit associations, informal moneylenders, supplier credit, and family loans, constitutes a substantial and theoretically distinct component of the capital structure of small firms in developing economies, yet mainstream capital structure theory is largely silent on its determinants and welfare implications. This study develops a theory of small firm capital structure that integrates formal and informal finance as endogenous financing choices and tests the theory's predictions using original firm-level data from Nigeria. The theoretical contribution is a capital structure model under credit market segmentation that derives conditions governing small firm optimal allocation between formal bank debt, informal financial instruments, and equity financing as a function of firm opacity, collateral capacity, relationship capital, and the relative cost of formal versus informal credit. The model generates original propositions about the complementarity and substitutability of formal and informal finance in firm capital structure and about the growth implications of shifting between the two financing regimes. The empirical application uses a novel dataset of 800 small firms across six Nigerian cities covering all geopolitical zones, gathered through an original enterprise census supplemented by a structured quantitative questionnaire capturing complete financing histories. The structural model is estimated using a multinomial endogenous switching regression, and the welfare implications of financing shifts are evaluated using counterfactual simulations. The theoretical framework integrates the pecking order theory, the relational finance literature, and the informal finance-growth nexus literature. The PhD-level contribution lies in the theoretical integration of informal finance into a rigorous capital structure model, the original multi-city dataset, and the structural estimation framework. Findings carry implications for the Bank of Industry, the Central Bank of Nigeria's development finance policy, and international scholars of informal finance. Keywords: informal finance, capital structure, small firms, Nigeria, rotating savings