Firm Investment decisions are related to financial factors. The amount of internal funds used by high-credit-worthiness firms is more sensitive than that of lower-credit-worthiness firms. This is evidenced by a large sample of firms that was sorted based on an objective sorting mechanism. Kaplan and Zingales (1997) found that firms that had the lowest financial constraints were most sensitive to internal cash flow. In contrast, firms that had higher levels of debt were more likely to have increased internal cash flow.
Despite this paradox, firms with low-to-low financial leverage finance more than their larger counterparts. This means that a high-growth firm can attract substantial financing from government sources. But the problem for small-firm financing is that government funding is usually not sufficient to compensate for weak legal and financial systems. Fortunately, alternative sources of finance such as trade credit fill this void. The key is to find the right mix of financing sources.
Financial leverage is negatively related to firm investment. This relationship is particularly strong in high-information asymmetric firms, but is less pronounced for low-growth firms. Private equity funds, however, are a viable alternative to traditional banking sources. And private peer investments are often financed with debt. Although this is a riskier way to finance an investment, the results still show that a firm that is undervalued has a higher chance of a successful exit.
In conclusion, public-sector misvaluation and private peer investment do not significantly vary. A more robust alternative is the shared sentiment hypothesis. While both hypotheses can be correct, the results suggest that private-sector investment in misvalued firms tends to be financed by debt. In this context, firms financing their misvalued investments with debt can be a key source of finance. These findings have important implications for the future development of small- and mid-sized firms.
Unlike the economic competition hypothesis, there is no significant relationship between private-sector investment in a firm’s peers’ misvaluation and its private-sector investments. Both hypotheses predict a negative relationship between public-sector investments in private-sector firms. This is not surprising given the relative lack of growth opportunities for underdeveloped firms. Moreover, the relationship between leverage and the amount of debt a firm raises is robust and positive in all cases.
Both hypotheses agree that misvaluation affects the amount of private-sector investments. A common measure of misvaluation is the price-to-fundamental ratio of a firm. Using this metric, we find a positive correlation between public and private investment in firms. This relationship exists when the firms are financed with debt. In contrast, the relationship between the two is significant when the firms are low-growth.
A fund manager manages the money of multiple investors in a single investment company. This makes it easy for individual investors to invest in a wide range of securities and earn dividends over time. This type of investment is called gearing. In a firm that gears, the investor invests in a firm that is already profitable. The fund manager then uses the profit to make more investments. While a fund manager will not make money from the same investments, the investor will lose money over time.
