Overinvestment, Leverage and Financial System Liquidity: A Challenging Approach

Forthcoming in Business Research Quarterly

19 Pages Posted: 22 Sep 2018

See all articles by Óscar López-de-Foronda

Óscar López-de-Foronda

University of Burgos - Department of Economics

Florencio Lopez de Silanes

SKEMA Business School; National Bureau of Economic Research (NBER)

Félix J. López-Iturriaga

University of Valladolid - Department of Financial Economics and Accounting; National Research University Higher School of Economics - International Laboratory of Intangible-driven Economy

Marcos Santamaría-Mariscal

University of Burgos

Date Written: September 1, 2018

Abstract

The aim of this paper is to analyse the influence of financial system liquidity and corporate leverage on a firm’s overinvestment. We posit that when external funds are easily available, as in expansionary monetary periods, debt loses its traditional role as a managerial control mechanism. Instead, the supply of systemic liquidity results in corporate leverage exacerbating the problem of overinvestment. Using a sample of over 12,400 companies from 25 OECD countries between 2003 and 2014, our results show a significant and positive relationship between corporate leverage and overinvestment when the liquidity of the financial system is high, confirming the shift in the role played by leverage. At the macroeconomic level, our research raises certain caveats concerning worldwide liquidity injections. At the microeconomic level, our study shows that the disciplinary role of debt might become a false friend when money abounds.

Keywords: Overinvestment; investment; leverage; debt; liquidity

JEL Classification: G32

Suggested Citation

Lopez de Foronda, Oscar and Lopez de Silanes, Florencio and Lopez-Iturriaga, Felix Javier and Santamaría-Mariscal, Marcos, Overinvestment, Leverage and Financial System Liquidity: A Challenging Approach (September 1, 2018). Forthcoming in Business Research Quarterly. Available at SSRN: https://ssrn.com/abstract=3242829

Oscar Lopez de Foronda

University of Burgos - Department of Economics ( email )

Plaza Infanta Elena
E09001 Burgos
Spain

Florencio Lopez de Silanes

SKEMA Business School ( email )

Avenue Willy Brandt, Euralille
Lille, 59777
France

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Felix Javier Lopez-Iturriaga (Contact Author)

University of Valladolid - Department of Financial Economics and Accounting ( email )

Avda. Valle Esgueva 6
47011 Valladolid
Spain
+34 983 184 395 (Phone)
+34 983 183830 (Fax)

HOME PAGE: http://www2.eco.uva.es/flopez

National Research University Higher School of Economics - International Laboratory of Intangible-driven Economy ( email )

Lebedeva,27
Perm, Perm 614070
Russia

Marcos Santamaría-Mariscal

University of Burgos ( email )

Plaza Infanta Elena
Burgos, Burgos 09001
Spain
34 947 258968 (Phone)

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