Firm Investment Decisions

The current economic crisis has forced many businesses to adopt more conservative investment strategies. As a result, many companies are being forced to look for alternatives that are cost-effective but offer substantial returns. In order to help businesses find ways to minimize their risk, finance managers have developed several theories in economic theory, including Firm Investment Theory.

Firm Investment

The research by economists from the International Monetary Fund (IMF), World bank, and other international organizations shows that firm investment leads to economic freedom and domestic credit freedom. The paper uncovers how firm investment directly and indirectly impacts firm investment. It is also seen that the effect of firm investment on domestic credit freedom is particularly important for high information asymmetrical firms. It is believed that firm investment can lead to greater financial flexibility because firms can use their retained earnings to invest in new projects or to finance projects that yield them higher returns.

There is also a rise in the number of firms that are operating from developing country countries. A clear example of this is the case of Wal Mart, which started out as a humble cloth manufacturer in the Midwest region of the USA. Today it has grown into one of the largest retail companies in the world. Developed nations such as Brazil, Mexico, India, and Vietnam import a large amount of capital and reinvest it in their economy.

One of the reasons why firms are investing in developing countries is because they see the potential in tapping into markets that have not been tapped before. This is because many people in these countries have access to technology. The next step then is for these firms to tap into the markets through infrastructure development, improved transportation, and the creation of new economic opportunities. Once these firms have gained access to the markets, they will have to reinvest the profits into building the infrastructure and creating new jobs. Once the cash flow increases and the firms continue to reinvest their profits, then they can see the fruits of their labor.

Another reason why firms make firm investment decisions to come to these underdeveloped countries is because they tend to make larger purchases than their developed counterparts do. The difference is that these countries are highly competitive. The other reason why firms choose to invest in these countries is because of the internal funds. Developed countries often have less available internal funds compared to the developed countries, which forces firms to look to the developing countries for additional capital.

The third constraint that the developing countries face is their external financing. The foreign money is needed to finance the projects of these domestic firms. Because domestic banks do not have the necessary capacity, or the willingness, to finance these projects, foreign firms must look to the capital markets. Capital coming from the international markets tends to be more attractive to firms because it offers greater liquidity. The other constraint that the developing countries face is their inability to increase their level of exports. This lack of export growth creates severe capital constraint within the country.