Financial Leverage and Firm Investment

Financial factors are closely related to firm investment decisions. High credit-worthiness firms are highly sensitive to internal funds, while firms with less credit-worthiness are less sensitive. Kaplan and Zingales (1997) found that the least constrained firms were most sensitive to internal cash flow. However, this relationship is not perfect. Moreover, many factors are correlated with firm investment decisions, such as the level of internal debt. As such, these relationships should be interpreted with caution.

Firm Investment

The relationship between firm investment and financial leverage is a strong negative one. The findings are stronger for low-growth firms, than for high-growth firms, where the relationship is weak or non-existent. In addition, the sample allows for analysis of different stages of firm development. This means that the effects of financial leverage are most obvious for high-growth firms. The underlying mechanisms that underlie the relationship between firm investment and financial leverage are the same for any company size, irrespective of the size.

It is generally recognized that a firm’s size influences the amount of capital invested. As such, a small-size business with low financial resources will struggle to compete with large companies. In these countries, however, government funding tends to be concentrated in larger firms. Therefore, these funds are not sufficient to cover the gap. Alternative sources of finance are insufficient. In these situations, trade credit is the only option. It is not a reliable source of capital in developing countries.

There is no definitive relationship between financial leverage and firm investment. The evidence is mixed for large and small firms, but is consistent with shared sentiment hypothesis. As previously mentioned, firms that receive public funding are also more likely to finance their investment. Nevertheless, private peer investments are a stronger proxy for misvaluation than large ones. These differences may explain why private peer investment is more likely to be made by smaller firms. These investments are typically financed through debt rather than equity, and in many cases, these loans are used to fund the misvaluation-induced investment.

In addition to these factors, financial leverage is negatively related to firm investment. It is only significant in firms with low-growth and information-asymmetric firms. It is not significantly related to firm size. It is important to note that firm size and financial systems are important considerations. For example, in many underdeveloped countries, trade credit is scarce, and financial institutions can be a source of capital. So, firms need external finance in order to expand their operations.

It is important to note that firm size and financial leverage are closely related. While financial leverage is a negative factor for all firms, it is positive for those with high-growth and information-asymmetric firms. In the long run, this effect is important to the success of a business. And the results are compelling. In some cases, the relationship between leverage and firm investment is even stronger than expected. If you are able to obtain adequate financing from a government agency, it can help your firm to survive.