The Role of Financial Leverage on Firm Investment

External financing accounts for over 40 percent of firm investment. About 19 percent of this financing comes from commercial banks. Another three percent comes from development banks. Less than two per cent comes from informal sources. The private sector is especially reliant on debt to finance misvaluation-induced investment. Despite the reliance on debt, private firms finance misvaluation-induced investment with debt. The reasons for this are unclear. In this article, we examine the role of financial leverage on firm investment.

When comparing two firms’ investment decisions, we find that they are not significantly affected by the extent of informality in the sector. Although this finding may seem contradictory, the results of the study suggest that financial restrictions in a sector affect investment decisions. In the case of Uruguay, the extent of informality does not directly impact a firm’s decision to invest, but it does have an effect on the channel in which firms borrow. Smaller firms borrow from more formal sources, such as the government, which may make their decisions more complicated.

Funding for investment by small firms has not significantly increased since 1990. This is partly due to the fact that the government and development banks prefer to fund larger firms. Moreover, the financial systems of smaller firms cannot compensate for their lack of access to formal finance. Alternative sources of finance do not fill this void. And trade credit, for example, is not widespread in poorer countries. The study concludes that the informality of a sector does not directly affect a firm’s decision to invest.

The extent of informality in a sector does not directly influence a firm’s decision to invest. However, the extent of informality can indirectly impact the channel of borrowing. The results of this study suggest that the presence of financial restrictions in Uruguay does not affect a firm’s investment decisions. Moreover, a one percentage-point increase in total credit growth translates into half-percent higher investment rates. While informality has no direct impact on a firm’s decision, it does have a positive impact on the level of credit available.

In addition to the financial sector, the level of informality can also affect a firm’s decision to invest. For instance, the extent of informality in a country’s financial sector affects a firm’s decision to invest. Its investment decisions depend on the level of informality in a country’s legal system. In a developing country, it is much more difficult for small firms to access finance for such purposes.

In a developing country, a government can provide capital to a small firm if it has a good credit rating. While small firms are likely to receive less government financing than larger firms, they can still be helped by other sources of finance. For example, large firms with a strong financial system are more likely to receive more international trade credit. Increasing small-firm investment financing is a politically popular policy in underdeveloped nations, but it can also lead to more inequitable investments.