This article examines the relationship between Financial Leverage and Firm Investment in Nigeria. This relationship is negative for firms that are publicly traded and positive for firms that are privately held. However, the evidence from these studies is mixed. In fact, the evidence for the positive relationship is weaker than the evidence for the negative relationship. The negative relationship of Financial Leverage and Growth is robust to other alternative empirical models. The reason why financial leverage and growth are positively related is that they are both factors that are important in determining firm investment.
Finance has a profound influence on investment decisions, even for small firms. Despite its importance, the Modigliani and Miller (1958) irrelevance proposition remains unchallenged. The presence of financial leverage complicates the relationship between firm investment and economic performance and introduces important determinants outside of the neoclassical fundamentals. Consequently, finance affects real investment decisions. This is an area where alternative sources of finance are needed.
In an era of incomplete markets, it is vital that small firms receive more financing from the government and development banks. In many underdeveloped countries, governments are more likely to give money to larger firms. Moreover, government funds are more effective in addressing underdevelopment because smaller firms are less likely to be able to compensate for weak financial and legal systems. Thus, in these countries, there is a clear need to expand the use of alternative sources of finance to make investments in small companies more sustainable.
The relationship between Financial Leverage and Firm Investment is not consistent and is not endogeneous. Instead, it is driven by the firms’ internal funds. A study of this relationship in a sample of firms reveals a strong positive relationship, even when there are differences in financial and legal systems. The findings also indicate that the positive relationship between these two variables cannot be explained solely by endogeneity. The authors’ findings are a positive sign for the relationship between Finance Leverage and Firm Investment.
There is a substantial theoretical and empirical literature on the relationship between finance and investment. Unlike in developed countries, finance does not always contribute substantially to firm investment, but it does have an impact on real investment decisions. For small firms, this is particularly true when it is outside the Miller-Modigliani world. Further, the research focuses on the role of internal funds in financial and investment decisions in underdeveloped nations. For example, in some underdeveloped countries, firms do not have a large capital base.
The return to formal job training is important for small firms. The return from this investment is higher than that of physical capital. This is because small firms are unable to compensate for the ineffectiveness of their financial and legal systems by using trade credit. The result is that these companies may not be able to afford to pay for the costs associated with the investment. This is a serious problem for small firms. And while they are not able to finance their investments, they still must pay for the cost of the training.