Save or Invest? How Companies Should Navigate Recessions
by Ioannis Ioannou and Caroline Flammer
The financial crisis and economic meltdown of 2007-2009 was disruptive for firms across industries, markets, and geographies. It resulted in the collapse of the financial sector, radical changes in the regulatory and policy environment, and a severe contraction of the world economy. In fact, an economic meltdown of this magnitude fundamentally affects all aspects of firms’ business environment, unsettles their relationships with customers, employees, suppliers, and local communities, and generates a major shift in the competitive landscape. Consequently, companies are likely to fundamentally rethink and reshape their strategic investments to ensure survival and sustain (or even enhance) their competitiveness during and after the crisis.
Indeed, one of the major challenges of an economic meltdown for strategic management is that it exacerbates resource constraints. As a result, companies might need to make fewer investments and divest from at least some of their previous ones in order to ensure survival in the short run. Doing so is a balancing act though, as divesting from too many resources — or picking the wrong ones — could jeopardize a firm’s ability to thrive in the long run.
Despite the severity of economic meltdowns, we know little about how exactly firms adjust their resource base as they navigate through the shifting landscape and new economic realities. To understand this phenomenon and its implications for companies, we set out to investigate how companies adjusted their strategic investments, i.e. their workforce, capital expenditures (CAPEX), R&D, and CSR investments. More specifically, we asked: How did companies adjust their resource base during the Great Recession of 2007-2009? Did they try to “save their way” or “invest their way” out of the crisis? In which direction and to what extent did they adjust their strategic investments to survive or even enhance their competitiveness?
It’s not obvious whether firms would decrease, maintain, or increase their investments, on average, since an economic meltdown presents firms with both challenges and opportunities. On one hand, an economic crisis may severely undermine firms’ ability to undertake investments because they’re short on cash. As a result, firms may lay off employees, divest from their physical assets, postpone or even cancel R&D projects, or eliminate CSR programs in order to maintain cash flows. In other words, firms may try to save their way out of the crisis.
On the other hand, an economic crisis may present an opportunity for firms to expand their investments; that is, they may try to invest their way out of the crisis. For example, an economic crisis might generate opportunities to acquire new equipment at lower cost or hire employees at lower wages. Moreover, firms could invest in their innovative capabilities and CSR to strengthen their competitiveness for when the economy recovers.
Using data for U.S. publicly-traded companies, we find that, overall, these firms significantly reduced their workforce and CAPEX during the Great Recession. Yet – remarkably — they maintained the same level of R&D and CSR. (To construct our sample, we use data from Standard and Poor’s Compustat database. After merging it with the KLD database – our source of CSR data – and with loan data from DealScan, we arrive at a sample of 670 companies for our main analysis.)
These findings suggest that companies, on average, responded to the crisis by following a “two-pronged” approach of simultaneously “saving their way out of the crisis” by reducing their workforce and CAPEX, and “investing their way out of the crisis” by sustaining their investments in R&D and CSR. Therefore, our results imply that innovation capability and stakeholder relationships were seen as instrumental in sustaining firms’ competitiveness during the Great Recession.
Importantly, we observe considerable differences across industries. While we find that on average firms did not reduce their investments in R&D and CSR, we document that some firms did—namely firms operating in less R&D-intensive and less CSR-sensitive industries, respectively. This result makes sense since, in these industries, firms’ competitiveness is less likely to depend on their innovative capability and stakeholder relations, respectively. The takeaway is that industry characteristics matter in understanding how firms adjust their resource base in response to an economic meltdown.
Finally, we examine whether companies that sustained their investments in R&D and CSR perform better in the years following the economic meltdown. We find that indeed they do. They exhibit higher operating performance—as measured by the return on assets (ROA)—in the post-crisis years. In contrast, we find that companies that maintained their workforce and CAPEX did not achieve higher performance. We also find that firms that pursue the two-pronged approach of simultaneously maintaining their R&D and CSR while reducing their workforce and CAPEX achieve an even higher performance in the post-crisis years.
Our findings therefore suggest that companies choose to maintain their investments in R&D and CSR as these resources may enable them to address key challenges that arise during the meltdown. First, by maintaining their investments in R&D during the meltdown, companies may find innovative ways to become more efficient—i.e., to do more with less—thereby enhancing their ability to maneuver through the meltdown. Second, communication and collaboration with the firm’s stakeholders are important factors in the firm’s processes. In this regard, firms that continue investing in stakeholder relations are likely better positioned to understand the changing conditions inherent to an economic meltdown, identify concerns and opportunities, and adapt to the shifting needs, demands, and expectations of suppliers, consumers, and other stakeholders, compared to firms that curtail such investments. Third, CSR can help firms differentiate themselves from their competitors, enhance firms’ ability to recover from unfavorable situations, strengthen connections with the local communities, improve labor productivity, enhance consumer loyalty, improve access to government procurement contracts, and lower capital constraints. These mechanisms are likely to be especially important during an economic meltdown, as they can improve companies’ resilience and, as a result, help companies maintain or even enhance their competitiveness.
Taken together, our findings suggest that firms that simultaneously “save their way out of the crisis” (by reducing their workforce and CAPEX) and “invest their way out of the crisis” (by sustaining their investments in R&D and CSR) are better able to adapt to the new and unique challenges brought about by an economic meltdown.