Presaging a Déjà Vu… The Impact of Leverage and Investment on Operating Performance Under Negative Demand-Driven Shocks

The early signs of economic slowdown portend a recap of the lessons of major recessions of the past. The paper revisits the impact of corporate investment and financing policies on operating performance under negative demand-driven shocks. Our study based on firm-level panel and cross-sectional data from the French stock market shows, that the outbreak of a recession may significantly alter the relevance of capital expenditures and leverage for the firms’ short- and medium-term operating performance. Increased investments at the outbreak of the financial crisis of 2008 appear to have deteriorated the medium-term performance of the French companies, while higher leverage might have alleviated the effects of economic downturn. In order to navigate through the recession and improve their operating performance, companies had to accompany incremental investment outlays with debt reduction and cash accumulation. The revealed patterns appear consistent with the logic of the ‘confidence theory’, whereby the overleveraged corporate sector makes an attempt to reduce debt burden and grow organically with recurrence to internal resources in order to restore value creating potential under credit crunch and tightening financing constraints.