Building on the pecking order theory of capital structure and financial flexibility arguments, this paper examines the relationship between a firm’s investment horizon and capital structure. The firm’s investment horizon is viewed as a measure of the firm’s temporal orientation and thus reflects the extent to which the resource-allocation process is long-term or short-term oriented.
We propose that firms with longer investment horizons rely more on external financing due to lower intermediate cash flows, but at a certain threshold, they rebalance their capital structure. Using panel data from 947,477 European firms (2018–2023), we test this hypothesis.
Results confirm a quadratic, inverted U-shaped relationship between investment horizon and financial leverage. The COVID-19 crisis influenced this relationship by shifting the rebalancing threshold.
Managers must balance long-term investment needs with financial flexibility, while policymakers should support firms in sustaining long-term strategies during economic downturns.
The paper extends classic corporate finance models of capital structure by integrating explicitly the importance for managers to maintain financial flexibility in the form of untapped debt capacity.
