Creative Destruction and the Bright Side of Economic Downturns
39 Pages Posted: 30 Jun 2020
Date Written: June 10, 2020
We find that business cycles drive productive economic churn. During recessions, firms with high previous abnormal investment scale back while firms with low abnormal investment scale up. These findings are consistent with an improvement in investment efficiency over the business cycle. Our estimates suggest that an average firm cuts inefficient investment during recessions by at least 7%, or roughly $145M. Valuation ratios converge similarly with inefficient firms showing relative improvement. Our results are stronger for less entrenched firms and firms with more shareholder filings (13D/G), which point to shareholder monitoring as an economic channel. Overall, investment efficiency appears to improve in recessions and decline in expansions, supporting Schumpeter's notion of creative destruction.
Keywords: Investment Efficiency, Economic Downturns, Overinvestment, Underinvestment, Shareholder Monitoring, Managerial Entrenchment
JEL Classification: G0, G30, G32
Suggested Citation: Suggested Citation