As an entrepreneur you may have already known that firm investment refers to the excess cash flow over fixed assets (usually fixed earnings per share). Financial Leverage is the ratio of net worth to tangible assets. It is also seen that the effect of financial Leverage on firm investment depends primarily on the type of company, its industry, and its financial returns over time. But no direct relationship is established between financial Leverage and firm investment for mid-size, low-growth companies.
There are a number of possible reasons why firms make decisions regarding capital structure and firm investment efficiency. One of the most important reasons for investment decisions is the perception of the company’s tangible assets. This perception can be affected by governmental policies such as tax hikes and the receipt of economic stimulus packages by firms around the world. In addition, these policies may affect capital costs for firms, especially in terms of increased subsidies and leniency towards unprofitable investments. To take advantage of these programs, most multinational corporations are turning to the government for assistance.
One of the reasons why the European Union and the United States have implemented policies that affect international capital movements is due to the global credit crunch that took place in 2021. During this financial crisis, financial institutions received large doses of bailout money from international lenders, but at the same time many domestic banks were forced to downsize or go into bankruptcy. The combination of governmental stimulus programs and bank recapitalizations has led to a mixed bag of results. Many believe that the combination of fiscal stimulus and bank rescues has led to more inefficient financial decisions and increased financial risks for banks. On the other hand, some analysts claim that there is no correlation between the receipt of government stimulus programs and poor domestic banking practices.
The presence of fiscal policy tools such as the European debt relief and the Bank rescue program enables governments to use their financial leverage to encourage firms to make additional firm investments in growing countries. The European debt relief fund, for instance, is designed to assist member states in restructuring their debts in order to allow for easier payments to be made by citizens. This measure, together with bank recapitalizations, is meant to prevent a major financial crisis period in Europe, which could lead to more negative implications on the international economy. In addition to these measures, the European Union has also started implementing a scheme that would see its budget adjusted based on the changes in economic output. These additional fiscal policies are meant to support economic recovery in Europe, thus providing a positive signal for firms to make additional investments.
However, implementing fiscal policies and bank recapitalizations do not mean that firms will instantly divert their resources towards better utilization. In fact, firms will need time to effectively implement the changes they need to make, as well as adjust to the new fiscal rules. While a significant portion of the fiscal package was aimed at increasing employment levels and reducing unemployment, the reduction of overall employment should not be viewed as a point in favor of firms that are struggling to increase employment because these measures will only make it more difficult for them to find and hire the people they need. To make up for this, firms will need to boost human capital, which is a key to both firm productivity and profit.
While increased government intervention can help boost economy through increased employment and reduction of unemployment, increased government intervention may also cause other negative effects. The possibility of increased government regulation that would affect company investment, for instance, may reduce firm investment efficiency, leading to a reduction in overall economic activity. Increased regulation may also lead to higher costs, leading to reduced capacity utilization and other negative implications on firms’ investments. Finally, increased government intervention may cause market friction, especially if the target country’s government differs from the target country’s government. This represents a setback to the target country’s overall economic recovery process.