The impact of leverage on discretionary investment: African evidence

Abstract

Purpose The purpose of this paper is to explore the impact of leverage on firms’ discretionary investment in Africa. Design/methodology/approach The authors employ a dynamic panel data model estimated with generalised method of moments (GMM) estimation techniques on the panel data of listed African non-financial firms. A dynamic model and the generalised methods of moments estimations are handy in controlling for unobserved heterogeneity, endogeneity, autocorrelation, heteroscedasticity, etc. Findings In spite of different settings, markets, leverage levels and methodologies, the authors found evidence that leverage constrains investment in African firms. The negative impact is more pronounced in firms with low-growth opportunities than in firms with high-growth opportunities. The results are inclined to the theory that leverage plays a disciplinary role to avoid overinvestment. Research limitations/implications African firms’ investment policy does not solely depend on the neoclassical fundamentals determinants of profitability, net worth and cash flows. Financing strategy also has a considerable bearing on the investment policy. The results provide evidence that leverage is a negative externality to the firm’s discretional investment policy for both lowly levered and highly leveraged firms. African firms’ should consider maintaining their low debt levels and rely more on internally generated funds so as not to suppress any available cash flows to interest payments and loan covenants from debt holders. Originality/value The study contributes to the literature on investment and financial leverage by the authors providing evidence from Africa, a developing continent, that has not been explored. It shows how conservative leverage levels of African firms, which have been reported to be rising, are impacting on investments. Pertaining to empirical methodology, the authors employ a dynamic panel data model, the GMM estimation technique, which is robust in controlling endogeneity, and a possible bi-directional causality between leverage and investment which have not been used in literature. The study also enables a comparison of the effect of high leverage and low leverage on firm’s discretional investment.

Asymmetric Information and Agency Cost of Financial Leverage and Corporate Investments: Evidence from Emerging South-East European Countries

“…Danso, Lartey, Fosu, Owusu-Agyei, and Uddin (2019), in research of sample of Indian firms during the 1995-2014 period, confirm the negative relationship of financial leverage with firm investment, which is stronger and significant for the firms with low growth opportunities, but no for firms with high growth opportunities. The same conclusion was reached for the African firms (Vengesai & Kwenda, 2018). K. Ahmad, Zulfiqar, Shah, Bilal, and Ahmad (2013), in the case of Pakistan for the 2000-2008 period, also find negative relationship between the firm leverage and investments, but the growth opportunities of the firm have no significance.…”

Mediation effects financial performance toward influences of corporate growth and assets utilization

“…Leverage signaling theory (Ross, 1977) mentions that debt is a credible sign reflecting the quality and the prospects of a company in the future, triggering positive reactions from the market upon the stock price of the company. A research carried out by Chowdhury and Chowdhury (2010), Bleck (2018), Oluwagbemiga (2013), Vengesai and Kwenda (2018) and Isaac (2014) confirmed that the capital structure has a positive and significant influence on the corporate market value. Trade-off theory (Modigliani and Miller, 1963), pecking order theory (Bhama et al, 2016), and leverage signaling theory (Ross, 1977) have been empirically proven.…”

Leverage and Investment Cash Flow Sensitivity: Evidence from Muscat Securities Market in Oman

“…Chen et al (2013) emphasized the role of corporate governance mechanisms and the lack of effective monitoring of managerial discretion may lead to the significant relationship between investments and cash flow. Vengesai and Kwenda (2018) investigated the impact of leverage on discretionary investment by using the panel data of non-financial firms in Africa. The results of their study revealed that leverage constraints investment with a disciplinary role avoiding over-investment.…”