Qual Quant (2010) 44:1005–1013
Firm leverage and investment decisions in an emerging
Published online: 7 May 2009
© Springer Science+Business Media B.V. 2009
Abstract In this study, the effect of leverage on investment is analyzed by employing panel
data methods for the Turkish non-ﬁnancial ﬁrms that are quoted on
Istanbul Stock Exchange.
For one-way error component models, it is shown that there is a negative impact of leverage
on investment for only ﬁrms with low Tobin’s Q. These results are in conformity with the
previous literature and agency theories of corporate ﬁnance stating that leverage has a disci-
plining role for ﬁrms with low growth opportunities. However, when the model is extended to
include the time effects in a two-way error component model, the relation between leverage
and investment disappears.
Keywords Leverage · Investment · Panel data · Emerging markets
Whether there is an optimal capital structure (debt to debt plus equity ratio) in the sense that
it maximizes the value of the ﬁrm is one of the most important issues in corporate ﬁnance.
The start of questioning this subject goes back to the seminal paper of Modigliani and Miller
(1958). The ﬁrst respondents to this question claimed that the value of the ﬁrm is indepen-
dent of its capital structure in a world with no taxes. But whenever the no tax assumption is
relaxed (and which must be relaxed for the sake of reality), the irrelevance of value of the
ﬁrm and capital structure does not hold any more. The reason is that the government subsi-
dizes interest payments by allowing the corporations to deduct them as expense. Therefore,
the market value of a ﬁrm can increase as it takes on more and more debt. So it seems that
being in debt will provide a tax shield advantage which in turn raises the value of the ﬁrm.
Thus, in theory the ﬁrm should entirely rely on debt ﬁnancing. However, it is not common to
M. Umutlu (
Department of Management, Çankaya University, 06530 Ankara, Turkey