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Four Hypotheses About Firms and Their Investment Structure

Firm Investment

Four Hypotheses About Firms and Their Investment Structure

One of the key criteria for selecting an appropriate financial manager is assessing firm investment policies, strategies, and techniques. It is also seen that the effect of financial leverage on firm investment can be major for high information asymmetrical firms. However, there is no clear relationship found between financial leverage and increased investment for low-information, high-profit firms. There are also mixed results found when comparing financial versus capital inflows.

One possible explanation lies in the fact that firms with limited human capital are not able to effectively increase their level of firm investment. For instance, there are some firms in the United States that are not able to attract and retain good employees. They have also been unsuccessful in implementing and maintaining an effective formal job training program. Also, the relatively poor quality of the skills of these employees limits the firms’ ability to manage and analyze information. This results in poor management and oversight of firm investments as well as poor allocation of resources.

In other instances, the problem lies in the fact that many firms are unaware of the importance of human capital. For instance, those firms that offer full-time positions in recruitment and placement may overlook the need for a professional HR manager. It is widely believed that such managers can better direct the focus of human capital. This may be true, but there is a disconnect between this belief and the reality found in many companies. Many firms are unable to find the right people in-house and out of employment because they do not take the time to perform a proper human capital analysis. In addition, there is a strong need for such studies to be done because companies cannot make informed decisions about firm investments without knowing what kind of workers they will be attracting.

Another hypothesis predicts that firm misvaluation will tend to occur when external disturbances cause investors to change the allocation of their capital. Investors do not make public firm investments in any effort to optimize returns. They make such investments only when they believe that their capital will be better utilized if they had them instead. When external disturbances create a significant change in the economy, investors tend to reallocate their funds to the same company that caused the original crisis. If a large amount of money is lost at a single point in time, investors may end up investing in a company that has already lost most of its assets.

Another hypothesis predicts that firm misvaluation-induced events will also tend to occur during times of economic slowdown. During these times, when the overall market is in negative territory, investors are more likely to liquidate their holdings. At this time, some of these assets may be productive. If investors wait until market conditions improve, most of their investments will be liquidated and most of their profits lost. When this occurs, a third hypothesis predicts that during times of economic downturn, investors will be more likely to retain their firm investments.

A fourth hypothesis predicts that firms will not change their portfolio structure on their own, especially during times of recession. Most managers do not have the experience or expertise to identify the appropriate mix of assets and liabilities. Therefore, during recessionary periods, they become too dependent on their firm investment advisers to guide them. Eventually, they begin to cut back on spending. The result is that most of the value of a firm’s assets is lost due to misvaluation-induced events.