Financial Leverage and Firm Investment

There is a strong link between financial leverage and firm investment. The relationship is negative for firms with high information asymmetry. It is positive for privately held firms. However, the relationship between firm investment and financial leverage is less pronounced. In both cases, private firms finance their investments with debt. Consequently, there is an indirect connection between firm investment and financial leverage. The effect of leverage on firm investment is mediated by the level of risk that controlling owners are willing to tolerate.

Firm Investment

Small firms do not finance investment in significant quantities from government and development banks. The funding that government and development banks provide is a better fit for larger firms, which are more likely to benefit from their legal and financial systems. Alternative sources of finance do not fill the gap, and rely on larger financial systems to provide financing. For instance, in developing countries, trade credit is not as prevalent, so smaller firms are less likely to benefit from government funding.

Small firms generally do not receive significantly more government or development bank financing than larger firms. Although programs aimed at expanding small-firm finance are a good political sell, the reality is that governments typically prefer larger firms over small ones. In addition, there are no reliable alternative sources of finance for smaller firms. This means that the government and development banks cannot adequately compensate for the underdeveloped legal and financial systems in developing countries. Because of this, alternatives to government and development bank financing don’t fill the void.

In addition, the government and development banks are unlikely to provide significantly more funding to small firms. In fact, the amount of government financing given to small firms is not statistically significant. The government is much more likely to fund larger companies, which are less likely to have adequate financial systems. Moreover, many small businesses do not have access to external markets, so these programs are a political soft sell. A more realistic approach would be to introduce alternative sources of finance to help the small firms grow and succeed.

Small firms do not receive significantly more government funding. Development banks and government agencies usually fund larger companies. Thus, programs that focus on expanding small-firm finance are a good political sell. While they do provide some benefits to small-firm finance, they tend to benefit larger firms. Often, this is because of the lack of access to external markets. If a firm can’t access these markets, it may be difficult for it to expand, and its financing needs are too small to compensate.

Small firms often have less access to external markets than larger ones. This has implications for both small and large companies. The public sector is likely to be more supportive of large firms than it is of smaller companies. And it may be easier for investors to invest in a small company if it is backed by strong government support. But the downside is that government-backed capital is unlikely to be as useful to small firms as it is for large enterprises.