Impact of Leverage on Firms’ Investment: Decoding the Indian Experience

Avdhesh Kumar Shukla & Tara Shankar Shaw in this new RBI WP:

This paper examined the impact of firm’s leverage on corporate investment in India. The findings of the paper suggested that the high leverage of firms has an adverse impact on their capital expenditure. Also, the relationship between leverage and firm’s investment was found to be non-linear.

Leverage at higher level affects investment decisions much more adversely, particularly for firms with lower investment opportunities. Leverage may affect a firm’s investment behaviour in multiple ways. It constrains firm’s capacity to mobilize external resources for financing new projects. It may discourage shareholders from supporting higher capital expenditure through increased borrowings, as in a scenario of high leverage, major gains from investment may accrue to debtholders (Krznar and Matheson, 2018).

We also find that firms increase their leverage during high economic growth phase, banking on the durability of such high growth. The findings of the paper suggest that the initiatives to clean up balance sheets of banks and deleveraging by non-financial corporates should help in the revival of investment cycle.

 

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