Financial leverage affects firm investment in the US. For publicly traded firms, the relationship is negative while for privately held firms, the relationship is positive. Both theories have their merits, but the main issue remains that financial leverage affects the allocation of firm resources. We will discuss the implications of the differences in these two perspectives. Besides highlighting the importance of financial leverage in the US, we will also examine how this type of financing affects the performance of private and public firms.
Increasing the availability of funds for small firms is not an easy sell politically. Governments often favor larger firms when it comes to funding, and this can cause an imbalance in the distribution of finance. In addition, small firms cannot compensate for underdeveloped legal and financial systems. Alternative sources of finance do not fill the gap. In the US, the largest and most diversified companies receive most of the government’s funding. However, the lack of access to trade credit in many countries makes it difficult for smaller firms to access capital.
Increasing the availability of small-firm finance is a good idea. This type of investment allows companies to invest more capital in more diverse ways. For instance, a financial company can invest in different segments. This way, it can maximize its income while minimizing its risk. The financial firm has a closed-ended structure, which means it has a fixed number of shares at a given point in time. Moreover, it requires fund managers to invest in less liquid assets.
While misvaluation-induced investment improves the future returns of both public and private firms, the effect on employment is modest. This is because the investment of public firms in the United States is more likely to be financed by the government than that of small firms. Additionally, private firms are more likely to use trade credit when overvaluation occurs, so the misvaluation effect does not matter. The effect on employment is much more significant in developing countries.
Governments are unlikely to provide significantly more money to small firms. Moreover, development banks and financial institutions usually favor larger companies, so if they do, the government funding will benefit only the largest firms. The same goes for international investments. While a small firm’s financial system may be weak, it is often able to attract investors. In such a scenario, public investment would increase. If the government increases the size of its economy, it could increase its profits.
Small-firms do not receive significantly more government funding than larger firms. While this is an easy political sell, it is not true that a small firm’s future returns will be lower than its current size. Even if the government does provide capital to smaller firms, the investment is not made by small companies. It is the governments that provide funds, not the private ones. This is a major advantage for both sides. For the latter, the government will also get more investment.
