Leverage Effect on Investment Efficiency in Over- and Underinvesting Firms: - A Study on Swedish Listed Firms 1997-2005

Abstract: This thesis studies the effects of leverage on investment efficiency in Swedish listed firms 1997-2005. The effects are studied separately for over- and underinvesting firms. To measure investment efficiency we employ three different measures: marginal q, absolute investments (defined as capital expenditures plus research and development expenditures) and Tobin’s Q. The application of three different investment efficiency measures rather than one is one of the main contributions of this thesis. The investment efficiency of overinvesting firms was hypothesized to be improved by higher leverage. The results based on marginal q accepted this hypothesis. The absolute investments and Tobin’s Q results could not accept nor reject the hypothesis, but indicated an improvement of investment efficiency for overinvesting firms as a result of increased leverage. For underinvesting firms, investment efficiency was hypothesized to decrease with leverage. The marginal q and Tobin’s Q results rejected this hypothesis. The absolute investments results could only accept this hypothesis on the 10% significance level. Thus, the results of this thesis indicate that investment efficiency increases with leverage for both groups of firms.