Financial Flexibility and Investment Ability Across the Euro Area and the UK

Abstract

We use a very large sample of European private and public firms to show that financial flexibility attained through a conservative leverage policy is more important for private, small‐medium‐sized, and young firms and for firms in countries with less access to credit and weaker investor protection. Further, using the 2007 financial crisis as a natural experiment, we show that a higher degree of financial flexibility allows firms to reduce the negative impact of liquidity shocks on investment. Our findings support the hypothesis that financial flexibility improves companies' ability to undertake future investment, despite market frictions hampering possible growth opportunities.

Corporate debt and investment: A firm-level analysis for stressed euro area countries

“…Finally, results for the Sargan-test of instrument validity indicate an issue already discussed in Ferrando et al (2017), who also report test results indicating strong rejection of the instrument set. Several studies have discussed the reliance on Sargan-test results in panels with dimensions similar to ours, and highlighted a tendency of strong over-rejection by the Sargan-test.…”

“…Net investment (defined as the annual percentage change in tangible fixed assets) is more relevant from a policy point of view given its close link to an economy's level of productivity (Kalemli-Özcan et al, 2015a). Gross investment (net investment plus depreciation) has a stronger theoretical motivation since financial constraints should affect both investment that replaces depreciated assets and new investment (Ferrando et al, 2017). We therefore show results both for net and gross investment.…”

“…As regards our leverage equation, we follow the existing literature and use a variety of firm characteristics identified to affect firm leverage (Rajan and Zingales, 1995;Coricelli et al, 2012;ECB, 2013;Ferrando et al, 2017) as controls.…”

Financial constraints and productivity: Evidence from euro area companies

“…This is particularly the case for Germany, where many firms choose not to file detailed annual reports and instead pay the small nonreporting fine. See, for instance, ECB (2013), Levine and Warusawitharana (2014), and Ferrando, Marchica, and Mura (2016). 8 Micro firms are defined as those with less than 10 workers and with sales (or assets) amounting to less than 2 million euros.…”

Financial Flexibility as an Investment Efficiency Factor in Asian Companies

“…Works by Byoun (2007) and DeAngelo and DeAngelo (2007) have primarily focused their attention on determining the sources of financial flexibility, while later research focuses more on the implications of flexibility and have a more holistic approach to its calculation. The connection between financial flexibility and investment activity relates to the pecking order theory of Myers and Majluf (1984) and was also covered by Yung et al (2015), Ferrando et al (2016) and others. Brief considerations of flexibility's effects on investment efficiency were described by Ma and Jin (2016), Nouri and Jafari (2016).…”