Financial Slack and Firm Performance During an Economic Downturn

Abstract

This conference contribution examines whether financial slack has an impact on performance in the particularly hostile environment of an economic downturn. Organizational theory posits that the impact of high levels of slack on performance should be positive during such a time, as excess resources buffer the core of the firm from external shocks. Using the most recent economic downturn in Germany, the paper investigates whether firms that built up excess resources up until the onset of the crisis experience superior performance during the downturn. Financial slack is measured along the following dimensions: The proportion of current assets to current liabilities, the ratio of equity to total debt, and the ratio of general and administrative expenses to sales (SG&A). These proxies are measured over a time period of five years prior to the crisis. Financial performance is then evaluated over the crisis and the initial recovery period. The results show that high pre-crisis levels of liquidity do not impact performance during a crisis. However, the findings support the view that high pre-crisis levels of debt have a negative impact on firm performance during the latest economic downturn. For slack stemming from the ratio of SG&A to sales, the association with performance was found to be positive, albeit at a declining rate. Both findings support the hypothesis that financial slack has value during an economic downturn. The originality of the approach lies in the evaluation of both linear and curvilinear performance effects of financial slack for German firms during an economic downturn.



Author Information
Andreas Gruener, University of St. Gallen, Switzerland
Ingeborg Raastad, SEB AG, Germany

Paper Information
Conference: EBMC2015
Stream: G – Financial Economics

This paper is part of the EBMC2015 Conference Proceedings (View)
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Posted by amp21