Firm Investments and Economic Growth

This article aims to highlight how financial Leverage effects company investment and the extent to which such a relationship is dependent on the extent of information asymmetry and growth. The paper is based on empirical data from 2, 403 Indian companies during the period 1994-2021, resulting in a significant sample size for examination. The analysis concentrates on five key aspects of company finance: (i) firm investment, (j) firm financing, (k) expansion, (l) operations and (m) sales and profit margins. The importance of company financing is illustrated through the implications of bank financing on company valuation and profitability. Finally, we investigate the impact of operations and sales on firm investment over time. Our analysis indicates that financial Leverage provides a consistent, powerful link between company investment decisions and subsequent profits.

Firm Investment

There are several potential sources of firm investment from which managers can choose, including retained earnings, marketable securities, fixed assets, goodwill and long-term debt. The analysis shows that only marketable securities and fixed assets are positively related to firm investment decisions. Our results indicate that firm size and cash flow are strongly related to firm investment decisions. However, our results are not consistent with all the literature, and various alternative models are suggested.

In this section we examine the relationships between domestic credit constraints and firm investment decisions. Our results suggest that credit constraint has a negative effect on firm investment because it increases the relative costs of production and reduce the rate of return, and consequently firm income and profits. The analysis is based on regression analyses using the General Accounting Principals (GAAP), a technique that can be used to evaluate the relationships between variables and rates of change. Consistent with the view that external finance has a significant impact on firm investment, the regression results suggest that firms with greater reliance on external finance are less successful than firms that have lesser reliance on external finance.

We next examine the relationship between external financing and firm growth. The regression results are suggestive of a positive association between firm growth and internal funds. A ten percent increase in internal funds is associated with a six percent increase in per-capita capital. The regression result is also statistically significant at the tails of the distribution, but provides no support for the assumption of equality of growth across the earnings distribution.

Finally, we address the distribution of wealth between capital and fixed assets. As expected, foreign competition has had a large and negative impact on domestic funding for U.S. firms. Foreign competition also weakens domestic financial capabilities, especially for smaller firms. The results imply that there is a negative correlation between domestic credit constraints and savings and investment, implying that a reduction in domestic credit market restrictions will increase the savings rate and decrease the capital stock. The results imply that the effects of foreign competition on firms financing constraints are likely to continue over the medium to long term. However, the current period of economic tranquility may provide opportunities for U.S. firms to respond to changes in the global credit markets and gain from their increased savings and investment.

This article has examined some of the issues regarding the relation between firm investments and firm growth. The current global economic downturn appears to be having a significant impact on U.S. firm investments. Some of this impact is coming from abroad, particularly from Asian countries where many U.S. companies have bases. Many other factors are likely to affect U.S. firm investments, including the balance of payments and the interest rates that are linked to the domestic money markets.