The relationship between public firm misvaluation and private peer investments is studied. In this study, we examine whether the misvaluation of publicly traded firms can affect the allocation of capital in private firms. The evidence is consistent with both hypotheses and robust to alternative treatments of growth opportunities. Moreover, our analysis indicates that the determinants of private firm investment are related to the portfolio diversification of the controlling owners. It also shows that private firms finance misvaluation-induced investments with debt, which is an important source of funds.
Financial leverage has a negative relationship with firm investment. The relationship is more pronounced for low-growth and information asymmetric firms. In contrast, there is no clear relationship between financial leverage and firm investment in high-growth firms. We also note that firm investment is negatively related to the presence of a competitive advantage. This implies that the greater the information asymmetrical a firm is, the more likely it is to be profitable. Consequently, the more asymmetric the firm’s information, the lower the likelihood that it will have a competitive edge and attract higher capital.
While there is a strong positive relationship between financial leverage and firm investment, the relationship between leverage and firm investment is not as strong for small firms. Larger firms receive government funding more easily, so government policies that aim to increase the availability of small-firm finance are likely to fail. Similarly, underdeveloped countries’ legal systems and financial systems are not conducive to investing in small firms. As such, alternative sources of finance are not sufficient to make up for the underdeveloped nature of small-firm financing.
The government and development banks do not significantly increase the amount of capital that small firms receive. This means that government funding for small-to-medium-sized firms tends to go to large ones. Even so, these programs are often politically appealing, but do little to remedy the underdeveloped situation in terms of financing. Because governments are more likely to provide funds to large corporations, it is not feasible for small companies to make up the difference. Therefore, alternative sources of capital do not fill this void.
In contrast to a large firm, a small firm is unlikely to receive government funds. However, government programs aimed at increasing the number of small-sized firms are likely to be an easy sell. These programs are usually focused on reducing the size of existing firms. For instance, a smaller firm’s size can have a negative impact on the ability of a company to attract finance. Its success is dependent on how much government funding a firm receives from various sources.
In the EU, a small-size firm is often underfunded, despite its significant contribution to GDP. This is in part due to the fact that smaller firms can’t compensate for an underdeveloped legal and financial system. Consequently, it is not possible for a small firm to secure government funds. Nevertheless, the government’s funds can help the firm raise capital. The financial system of a country can play an important role in facilitating investment in a small-scale firm.
