Table 1 provides descriptive statistics on the investment and financial data for the sample of the 15 listed non-financial firms during the period 2000-2009. The sample consists of firms operating in 4 different sectors. It is to be noted furthermore that for the purpose of the descriptive analysis, the use of LOG was not taken into account.

Inspection of the table reveals a high variation of investment among the listed non financial firms. The mean of the ratio of investment to total assets is 0.046, while the standard deviation is 0.072 which is about one and a half times the mean. The sample average Tobin’s Q of 0.72 reflects market expectations of quite strong growth opportunities for the firms. The mean of the leverage is 0.13 which suggests there is not so much reliance on long term debt finance and thus firms are not so highly leveraged.

5.2 Table 5: Correlation among Independent Variables

Investment

Leverage

Profitability

Cash Flow

Sales

Tobins Q

Investment

1

Leverage

-0.09

1

Profitability

0.29

-0.08

1

Cash Flow

0.29

-0.07

0.85

1

Sales

0.74

0.10

0.42

0.48

1

Tobins Q

-0.07

0.18

0.09

0.12

-0.05

1

Table 3 presents Correlation Coefficients for the variables used to assess the impact of leverage on firm investment. Investment is negatively correlated with leverage and Tobin’s Q. Except for Tobin’s Q where a positive relationship was expected, the other variable support the theory and gives the expected results as the case of leverage supporting the Agency Theory. But this negative related Tobin’s Q can be explained using the Low and high growth firms statement. This positive relation for profitability and business size is consistent with the pecking order theory and trade-off theory. Cash flow???

For instance, profitability may be positively related to cash flows since high cash flows may help in day to day running of a firm’s business. As seen in the above table, the correlation between profitability and cash flow are high, which is 0.8489.

Fixed or random table

Table: Random and Fixed tests

Variables

Fixed

Random

Coefficient

p-value

Coefficient

Leverage

-0.23

0.00

-0.22

Profitability

0.22

0.30

0.21

Cash flow

-0.30

0.25

-0.30

Tobins Q

0.57

0.04

0.42

Sales

0.72

0.00

0.75

R-square = 0. 5886

Prob > F = 0.0000

corr(u_i, Xb) = 0

No of Observation: 150

No of Company: 10

The Random Effect Model as well shows that not all variables are significant. However, the value of R-squared (R-sq) is 0.5886. This shows that the independent variables of the current model explain 58.86% of the investment opportunities of Mauritian firms. In fixed effect test, leverage, Tobin’Q, sales are significant in explaining investment. In the random effect model, only leverage, and sales are significant.

Table 3: Hausman Test

Hausman

Prob>chi2 = 0.65

According to the Hausman test the Prob>chi2=0.65 as seen in Table 3. The result obtained show that the random effect model is the appropriate model to use. The random effect assumes that the error term is uncorrelated with the dependent variables.

Random effect tests

Table: Random test

Variables

Coefficient

p-value

t-ratios

Leverage

-0.21

0.00

-9.94

Profitability

0.14

0.03

2.15

Cash flow

-0.22

0.00

-2.78

Tobins Q

0.17

0.07

1.84

Sales

0.76

0.00

32.97

The results, shown on the Table , are rather encouraging since the significance of the overall regression illustrates the existence of a relationship between investment opportunities and the determinants analysed. Apart from Tobin’s Q, all the other determinants are significant to the model. The most interesting factor, however, is given by the fact that all of the coefficients of the exogenous variables have the predicted sign except cash flow which is negative.

Leverage

Our variable of interest, i.e., the leverage is statistically significant at 1% and is negatively related to net investment as 1 unit increase of leverage ratio leads to a 21.43 % decrease in net investment suggesting that capital structure plays an important role in the firm’s investment policies. This implies that as leverage increases, firms in the sample struggle to increase investment. In fact, net investment decreases, as firms tend to become more dependent on debt as a source of long term financing. T

The negative effect of leverage of firm investment tallies with the underinvestment and overinvestment theory and furthermore, As Myers (1977) stated earlier, that leverage is negatively related to investment because of an agency problem between shareholders and bondholders. If managers work in the interest of shareholders, they may give up some positive net present value projects in the interest of shareholders due to debt overhang. The theories of Jensen (1986), Stulz (1990) and Grossman and Hart (1982) also claimed leverage to have a negative effect on investment but their arguments are founded on agency problems between managers and shareholders. They believed that firms with free cash flow but low growth opportunities may invest or overinvest such that the manager may take on projects with negative NPV. But, such strategy is not costless to the manager, especially if the capital market takes into account such potential opportunism or if there is a take over of the firm by another company, managers tend to increase leverage and pay out cash as interest and principal. Furthermore, there are direct costs involved in raising external funding, such as underwriting and administrative fees. There is also potential financial distress costs associated with using external finance. For example, as leverage increases, other things being equal, there may be a higher probability of the firm facing financial distress. In this case, the firm may incur direct bankruptcy costs such as legal expenses and trustee fees and indirect costs such as the disruption of operations, loss of suppliers or customers and the imposition of financial constraints. The present value of these expected costs should be reflected in current financing costs. Finally, there are issues of taxation, shareholder dilution, control of information, the need to maintain flexibility and liquidity that may also have an impact on a firm’s financing choices. Financial factors may therefore affect the cost and availability of capital and so influence the investment decision

Profitability

The coefficient for profitability is 13.79 which is statistically significant at 3.1% and is positively related to investment. It indicates that the operating efficiency of the total funds over investments is positive. Usually, high profitability also attracts funds from investors for expansion and growth. Furthermore, it contributes towards the social overheads for the welfare of the society and there is an effective use of capital. This result is consistent with the empirical literature whereby Myres, 1984 stated that firms prefer to finance new investments from retained earnings and raise debt capital only if the former is insufficient, the availability of internal capital depends on the profitability of the firm. This fact is in line with the pecking order theory

Cash Flow

From the results obtained from table above, it can be noted that cash flow is significant at 1% but it is negatively related to investment opportunities since as 1 unit increase of cash flow ratio leads to a 22.47 decrease in net investment. The overall negative and significant coefficient of cash flow suggests that overinvestment is severed in overinvesting firms if they hold more cash. According to Jensen (1986) as the free cash flows of overinvesting managers increase, so should the overinvestment, as they have more funds to waste

The contradicting and statistically weak result might be explained by the fact that cash holdings for the funding of projects are of relatively little relevance to the studied group of firms, since the studied firms should have favorable access to external capital by being listed. Thus, the firms might fund their projects directly by share or debt issues, instead of building cash reserves. Possessing free cash flow is rather beneficial for a firm, but having excessive dormant cash flow is relatively is not good.

When free cash flow is present and shareholding monitoring is incomplete, the typical manager-shareholder monitoring agency problem arises. Managers have a tendency to overinvest even in negative NPV projects while shareholders would prefer dividends to eliminate the free cash flow. Cash flow is rather used maybe for paying out dividend, debt-finance share repurchase, and the like.

As argued by Whited (1992), Gomes (2001), Alti (2003), Cummins et al. (2006) among others, one important caution in the analysis that might explain the contradictory findings in the literature is that cash flow might convey information about the firm’s future investment opportunities. When this is the case, a significant cash flow and investment relationship might be observed that reflects increased investment opportunities rather than signalling financing frictions. In other words, the observed relation between cash flow and investment might be a spurious effect resulting from the inability to control for investment opportunities in the underlying investment equation.

The investment of firms with higher leverage may be more sensitive to cash flows than that of firms with lower leverage. The increased debt servicing obligations resulting from higher leverage mean that the available cash flows of higher-geared firms are smaller and thus they have less of a buffer against disturbances.

Sales

It can be seen that firms are utilizing their total assets efficiently and it reflects the ability in producing large sales volume. The estimates of sales is 75.94 and the variable is statistically significant at 1%. Sales revenue does not support the popular belief that firm with more debt are investing to a lesser degree than their sales would suggest.

This finding corresponds to that of Kopcke and Howrey (1994) who found that investment of 396 companies was not dependent on the sales revenue of the firms.

Tobin’s Q

From the table, it can be seen that Tobin’s Q is statistically insignificant at 6.5% and is positively related with investment. The regression estimate is 17.44. Firms which have a propensity to expand the scale of the business and management’s ability to carry out such a policy is constrained by the availability of free cash flows and this constraint can be further tightened via financial leverage. The issuance of debt engages the firm to pay cash as interest and principal, forcing the managers to service such commitments with the funds that may have otherwise been allocated for investment projects.

Hayashi (1982) explained that the Tobin’s Q variable should be an adequate enough variable to explain firm investment. However, if a major impact of Tobin’s Q is the presence of "bubbles," forms of irrationality such as herding and other factors, then it might not be a statistic that captures the relevant information about profitability of projects invested in. In addition, he assumes that the market is fully efficient, the firm exhibits constant returns to scale and importantly, these firms have no market power.

HIGH AND LOW GROWTH FIRM

Arrellano and Bond Test

Table: Arrellano and Bond

Variables

Coefficient

p-value

t-ratios

Investmentlag

-0.18

0.79

-0.26

Leverage

0.04

0.82

0.23

Profitability

-0.33

0.94

-0.07

Cash flow

0.50

0.91

0.11

Tobins Q

0.73

0.78

0.27

Sales

0.06

0.97

0.04

The GMM results show that investment lag is not significant. There is no causality in investment.

Sargan Tests

Sargan

p-value : 1.000

The p-value is above the 0.05. It indicates that the model is valid. The model passes the sargan test.

Abond test

abond

p-value

Order 1

Order 2

0.79

0.26

The p-value for both of Order 1 and Order 2 is greater than 0.05. There is no evidence of serial correlation in the dataset.