The impact of leverage on investment decisions for South African firms with different growth opportunities

Miriam Mondosha,Akios Majoni

doi:10.4102/jef.v11i1.192

Miriam Mondosha, Akios Majoni

Open Access

https://doi.org/10.4102/jef.v11i1.192

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Abstract

Research has documented a significant relationship between financial leverage and investment decisions, however divergent views exist about whether this relationship is explained by the underinvestment hypothesis or the overinvestment hypothesis. This study examines the relationship between financial leverage and investment decisions for firms with different growth opportunities, it is based on a sample of 51 industrial sector firms listed on the Johannesburg Stock Exchange (JSE), South Africa, over the period from 2008 to 2014. Using panel data and after controlling for heterogeneity across firms, we report a negative relationship between leverage and investment. However, the relationship is significant for firms with high growth opportunities and insignificant for firms in the low growth category. The results support the underinvestment theory that debt overhang reduces the incentives of firms exploiting valuable opportunities.

Highlights

We examine the impact of leverage on capital investments in the South African context
We examine the empirical relationship between leverage and investments using ordinary least squares (OLS) regression as per Equation (1)
This study examines the relationship between financial leverage and investment using two different proxies of leverage

Summary

Introduction

We examine the impact of leverage on capital investments in the South African context. Literature has evolved to criticise this view and to recognise that the amount of leverage on the firm’s balance sheet does affect capital investments (Ahn, Denis & Denis 2006; Aivazian, Ge & Qiu 2005), and it does so in two different ways: firstly, leverage disincentivises firms from taking on investments, leading to underinvestment (referred to as the underinvestment hypothesis). Proponents of this hypothesis argue that leverage has the potential to reduce the incentives, for the ‘shareholdermanagement coalition’, to invest in capital projects because the benefits will partially accrue to bondholders (Ahn et al 2006). Leverage plays a role in curbing overinvestment (referred to as the overinvestment hypothesis) by self-centred management who desire to serve their personal interests (e.g. through empire building), while destroying shareholder value (Aivazian et al 2005)

Results

Discussion

Conclusion