Which Investments Do Firms Protect? Liquidity Management and Real Adjustments When Access to Finance Falls Sharply

44 Pages Posted: 13 Jul 2014

See all articles by James R. Brown

James R. Brown

Iowa State University - Department of Finance

Bruce C. Petersen

Washington University in St. Louis - Department of Economics

Date Written: July 3, 2014

Abstract

We study how firms engaged in both R&D and fixed investment manage liquidity and adjust real investment during the recent financial crisis. Among firms with positive R&D expenditures, cuts to fixed investment in the crisis are typically far more severe than cuts to R&D. These firms allocate cash reserves to buffer R&D but do not use cash to protect fixed investment. Some firms appear to go so far as to allow the stock of fixed assets to fall to stabilize R&D. The use of cash holdings and fixed assets to protect R&D is particularly strong among firms most likely to face financing frictions at the start of the crisis. We only find evidence that firms use cash to buffer fixed investment when we expand the sample to include firms with no R&D spending to compete for funds. Our study provides direct evidence on the real effects of liquidity management, highlights a key benefit of precautionary cash reserves, and illustrates the adjustments firms make to navigate a financial crisis.

Keywords: Liquidity management, value of cash, financial flexibility, R&D, fixed investment, financial crisis

JEL Classification: G01, G31, G32

Suggested Citation

Brown, James R. and Petersen, Bruce Clayton, Which Investments Do Firms Protect? Liquidity Management and Real Adjustments When Access to Finance Falls Sharply (July 3, 2014). Available at SSRN: https://ssrn.com/abstract=2465404 or http://dx.doi.org/10.2139/ssrn.2465404

James R. Brown (Contact Author)

Iowa State University - Department of Finance ( email )

Ivy College of Business
Ames, IA 50011
United States
5152944668 (Phone)

Bruce Clayton Petersen

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States
314-935-5643 (Phone)

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