Leverage, Investment and Institutional Environments: Evidence from Emerging Markets

Abstract

We examine the link between investment and leverage internationally, bringing evidence from 22 emerging economies. We show a negative effect of leverage on investment that becomes stronger for low growth firms, in line with the overinvestment hypothesis. We further find that the monitoring effect of leverage on investment is stronger on firms operating in low regulatory quality and corrupt environments. Finally, we show that the monitoring effect induced by ownership concentration complements the monitoring effect of leverage on investment. Overall, our results suggest that the increased debt levels reported in emerging markets in recent years, act as a disciplinary tool against overinvestment, especially in countries with weak institutional environments.

Keywords: Capital structure, Institutional quality, Investment; Leverage, Ownership concentration, Emerging markets

JEL Classification: G20, G30