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Top1. Introduction
Leverage is an external funding source used by companies in the form of debt from creditors. The consequence of using leverage is that the company is burdened by interest charges. Leverage has an important role in the management of corporate finance, as it can affect investment policies and company dividend policies. Leverage is associated with corporate investment funding activities. Leverage can also affect the value of the company. The role leverage plays has encouraged many academics to analyze it comprehensively.
Leverage can help financial activities, both for funding activities and investment activities. Leverage can also affect financial policies, i.e. funding policies, investment policies, and dividend policies. Leverage is not only useful in helping companies related to their financial operations, but it also represents a mechanism for companies to be able to create corporate values. Miller and Modigliani (1961) reveal that companies that use leverage will be able to reduce corporate tax payments, thereby increasing the value of the company. Ross (1977) also reveals that companies that use leverage are considered or trusted as companies that have good business prospects in the future, leading to an increase in the value of the company.
First, leverage has an important role in investment activities. Several alternatives are available to fund investments, namely: a) retained earnings, b) leverage, and c) issued shares. Myers (1984) state that the order of a funding structure in companies consists of retained earnings in the first place, then followed by the use of leverage, and the last alternative is the issued shares; this was later known as pecking order theory. The rationale of Myers (1984) is that the source of funding that has the lowest capital cost is retained earnings, so this comes in the first place.
Second, the use of corporate leverage also affects investment policies and corporate dividend decisions. In general, leverage is used by companies as one of the funding mechanisms for corporate investment activities. A company uses leverage when it experiences a lack of funding from retained earnings. The greater the lack of funding for corporate investment, the higher the amount of leverage used. When referring to the pecking order theory (Myers, 1984), new companies will use leverage because companies experience a lack of investment funding. The use of leverage is also motivated to (a) supervise the actions of creditors to company managers (Easterbrook, 1984; Jensen, 1986), and (b) transfer the risk from company shareholders to creditors (Kalay, 1982). On the other hand, the use of leverage by the company can also influence the dividend policies. The higher the use of leverage by the company as a source of funding, the more restricted the dividend policies will be. Based on the debt covenant theory (Kalay, 1982), companies that use high amounts of leverage are those that tend to pay dividends in small amounts or even not paying dividends.
Third, the use of corporate leverage also affects the value creation of the company. The ultimate goal of corporate financial management is on how companies increase its value. The value creation has led to many studies to find out the mechanism to maximize it, whether through leverage or investment or paying dividends.
This research re-examines the positive role of leverage on investment policies, dividend policies, and corporate value creation. Previous opinions have stated that the use of high leverage will bring a positive impact on corporate investment funding—the higher the investment, the higher the profitability of the company will be. High profitability will cause the company to have the ability to pay dividends to shareholders. Companies that fund high amounts of investment and pay high dividends will have high corporate value.