Does the inverted U-shape between corporate indebtedness and investment hold up for emerging markets? Evidence from Türkiye

Abstract

While corporate indebtedness has increased substantially in emerging countries over the last decade, the literature on the negative consequences of this large build-up of debt on real consequences is very limited. In addition, they provide mixed results and suffer from the lack of representativeness of their samples, which can be attributed to data availability. Unlike the previous studies, this study investigates the link between corporate indebtedness and investment by utilizing a novel firm-level data covering the universe of all incorporated manufacturing firms in Türkiye over the last decade. The results of the panel regression model with multi-dimensional fixed effects provide significant evidence of an inverted-U relationship between indebtedness and investment, indicating that leverage increases investment up to a certain level, and after that, further increase in leverage has an adverse impact on investment. This non-monotonic relationship is evident for all firm size groups. Conspicuously, the indebtedness level that impedes investment is significantly lower for Small- and Medium-Sized Enterprises (SMEs) than large firms, which supports the arguments that small firms are more likely to be affected by debt overhang. Results also reveal that firms holding more cash can sustain higher levels of debt without hurting investment activity. This is also the case for high capital-intensive firms and exporters. Findings of this paper highlight the importance of policies to make equity financing more attractive, incentivize the uptake and provision of equity capital from private investors, and deepen the capital markets.