This study investigates the longstanding underperformance of UK business investment and examines how firms’ external financing conditions and internal investment thresholds shape investment behaviour between 2013 and 2022. Employing a comprehensive firm-level dataset, the analysis examines heterogeneity by listing status, firm size, and financial constraints.
The results show a significant negative relationship between market-based financing costs, especially the cost of debt, and tangible investment. This effect is particularly pronounced for unlisted, smaller, lower productivity, and financially constrained firms. By contrast, intangible investment is much less sensitive to observed financing costs, consistent with its greater reliance on internal funds, higher uncertainty, lower collateral value, and more heterogeneous payoff horizons.
A further contribution of the paper is to distinguish externally observed financing costs from internally applied hurdle rates. We find clear evidence that firms’ internal hurdle rates are substantially higher than standard market-based financing benchmarks. The average hurdle rate (10.7%) exceeds firm-level market-based capital cost measures by around 350–430 basis points. This internal–external wedge is significantly associated with lower investment, particularly among large and listed firms. Taken together, the findings suggest that both differences in financing conditions and firms’ internal capital budgeting rules are important drivers of the UK’s weak investment
performance.
Authors Yongyi Xue, Catherine L. Mann