Corporate Indebtedness and Investment: Micro Evidence of an Inverted U-Shape

This study investigates the link between corporate indebtedness and investment by utilizing a novel firm-level data, which contains the universe of all incorporated manufacturing firms in Turkey over the last decade. The results of the panel regression model with multi-dimensional fixed effects provide significant evidence of an inverted-U relationship between indebtedness and investment, indicating that leverage increases investment up to a certain level, and after that further increase in leverage has an adverse impact on investment. This non-monotonic relationship is evident for all firm size groups. Conspicuously, the indebtedness level that becomes an impediment to investment is significantly lower for SMEs than large firms, which is in support of the arguments that small firms are more likely to be affected by debt overhang. Results also reveal that firms holding more cash can sustain higher level of debts without hurting investment activity. This is also the case for high capital-intensive firms and exporters. Findings of this paper highlight the importance of policies to make equity financing more attractive, incentivise the uptake and provision of equity capital from private investors, and deepen the capital markets.