Leverage, Investment, and Firm Growth

Abstract

This paper documents a negative relation between current leverage and future growth. This relation holds within and across industries, when leverage is assumed to depend directly on future growth, and irrespective of which variables are used to forecast growth. Its economic significance exceeds the economic significance of the relation between cash flow and future growth documented in the literature. It holds for low q firms but not for high q firms or for firms in high q industries. Therefore, leverage does not reduce growth for firms known to have good investment opportunities but it is negatively related to growth for firms whose growth opportunities are not recognized by the capital markets and for firms whose growth opportunities are not sufficiently valuable to overcome the effects of their debt overhang.