The financial factors that influence firm investment are important in the decision making process. Internal funds are a crucial source of finance for firms of high creditworthiness. The more internal funds a firm has, the greater its profit. Evidence from large samples of companies suggests that the highest quality firms are most sensitive to the use of internal funds. In contrast, the least creditworthy firms tend to be less sensitive. A study by Kaplan and Zingales (1997) found that the least constrained firms are the most sensitive to internal cash flow.
The relationship between financial leverage and firm investment is negative for high-information-asymmetric firms. This relationship is non-existent for low-growth firms. Further, the coefficients for financial leverage and current investment to capital are both positive and statistically significant. These results support the view that external funds play an important role in firm growth, particularly in developing countries. However, it is still unknown whether financial constraints affect the investment decision process in high-growth firms.
Earlier research has suggested that the financial leverage of a firm affects its investment decisions. Although the relationship between financial leverage and firm investment is not statistically significant for high-growth firms, it is significant for low-growth firms. Further, the amount of leverage used by a firm in the process of firm investment is correlated with the firm’s growth rate. This suggests that the higher a firm’s leverage, the more its investment is likely to increase in the short term.
As such, the relationship between financial leverage and firm investment is highly significant for low-growth firms and large-scale firms in high-information-asymmetric countries. The relationship between financial leverage and firm investment is negative for both high-growth firms and low-information-asymmetric firms. This relationship is less pronounced for high-growth firms. As a result, firm investments depend on a firm’s internal finance and macroeconomic credit conditions.
In both the whole sample and firm-size effect, the financial leverage of a firm has a positive relationship with the investment of another firm. This relationship is most robust for low-growth firms, while it is not significant for high-growth firms. In the present-day sample, the relationship between financial leverage and the ratio of a firm’s investment to capital is positive. Moreover, in both high-growth firms, a higher level of debt implies that the financing ratio of a company is higher in the past.
The study shows that the economic factors that affect a firm’s growth and profitability are important to its development. In addition, the size of a firm is an important consideration when analyzing the relationship between investment and capital. The greater a firm’s size, the more likely it is to invest in the future. A high level of internal finance is necessary for a business to survive. Hence, firms in developing countries should be given special attention to the credit constraints in their country.