Abstract

The purpose of this study was to analyze the relationship between financial leverage and firm’s investment in the presence of certain control variables such as (Tobin’s Q, cash flow, liquidity, return on equity and sale. Relationship was analyzed by applying different methodologies such as pooled regression, fixed effect model and random effect model. Housman test was performed for selection between fixed and random effect model. Data was taken from balance sheet analysis of joint stock companies, annual reports of the companies, B recorder and Karachi Stock Exchange. Data was collected for nine years from 2000-2008, but analyses were performed for eight years because 2000 was taken as a lag. This study found that financial leverage has significant negative impact on firms’ investment. It shows that as leverage increases firm’s investment decreases, we may say that highly levered firms invest less. The result confirms that leverage overcome overinvestment bias and attenuate agency problem. The results of the common effect model supported that capital structure plays a vital role in the decisions of firms on how to invest. But whenever we extended the model to incorporate the time and individual effect, then no relationship were seen. The relationship between liquidity and investment is positive but insignificant. Tobin’s Q has also shown positive but slightly insignificant relationship with investment for the target samples.

Key words: Tobin’s Q, cash flow, liquidity, return on equity, sale, Karachi stock exchange.