Firm Investments in International Markets
The relationship between firm investment growth and firm growth is studied in a new paper by drawing implications from agency theory, the study finds that financial leverage at the firm level is significantly and negatively correlated with firm growth. In other words, it is also seen that the effect of financial leverage on firm growth is very significant for high information asymmetrical firms. The authors do not explore in detail the causes behind this correlation but one can reasonably infer that the decline in financial assets at the firm level is a major contributing factor for the observed negative correlation. However, one cannot ignore the fact that the authors are finance experts and therefore it is not surprising that they would only investigate the relationship between financial assets and firm growth at the firm level.
Another important aspect that is explored in this paper is the concept of misvaluation. The hypothesis observes that ‘firm misvaluation’ refers to situations when private shareholders to sell all or part of their holdings in a company due to poor performance. They argue that misvaluation can affect investment decisions because in bad times investors tend to sell their holdings even if the companies are still profitable. In good times, when markets are bullish, investors will hang onto their stocks.
Another aspect that is explored in this paper is the impact of derivative instruments. Specifically, they argue that the use of forward contracts by public firms may result in significant losses because future payments are based on prices that are not determined today. As such, the hypothesis predicts that the occurrence of misvaluation-induced losses will be dependent upon the extent of misvaluation; hence, future payments will be higher in times of substantial stock market declines. While this hypothesis has a strong probability of being correct, it is not established by any means. There is a large body of research on the causes of stock price fluctuations, and while most agree that expectations are important in terms of prices (e.g., Merton et al. 2021), expectations have been shown to vary greatly between different countries (e.g., Kaplan and Kauffman 2021).
One final area that they touch on in their analysis is the impact of changes in exchange rates. Specifically, they examine changes in four rate trends, three of which they say are widely held across many nations. They then examine the effect of these rates on firm fixed earnings and net worth over time periods ranging from six months to five years. Overall, they find that changes in currency rates do not significantly affect firm balance sheets. However, they caution that these results are driven more by a tendency for investors to convert floating assets into hard assets during good economic times, which they assume leads to a reduction in corporate bond prices.
Their main focus of this paper is on examining international firm investments. Specifically, they examine two specific types of foreign investment: fixed income and equities. Fixed income securities include bonds, mutual funds, insurance, and other similar assets. During periods of financial stress, when market conditions are fluctuating and markets are experiencing large changes, fixed income assets tend to benefit from these conditions, with some exceptions. When markets are on the rise, equity financing tends to lag behind fixed income, with some of the gap occurring because of governmental policies (e.g., low interest rates and subsidies) that increase both liquidity and equity returns. On the other hand, equity financing tends to underperform fixed income during boom times, as companies take advantage of greater access to capital and household savings begin to accumulate again.
Overall, the study concludes that changes in the exchange rate do have an effect on firm balance sheets, with the exception of very short time periods. They also find that over longer time periods, both equity financing and fixed income are largely unaffected by fluctuating markets. The research draws a conclusion that increases in government regulation, if accompanied by an appropriate program of infrastructure investment, can help support a stronger economic recovery.