The Dog That Didn’t Bark: Long-Term Strategies In Times Of Recession

Written by Ioannis Ioannou

Full paper available at SSRN.

The recent economic and financial crisis of 2007-2009 had dramatic consequences for individuals, communities, corporations, and governments around the world. In fact, the period of the crisis has been named the “Great Recession” because it is the worst post-World War II contraction on record.[1] According to the U.S. Department of Labor, the U.S. gross domestic product (GDP) contracted by approximately 5.1% between December 2007 and June 2009. About 8.7 million jobs were lost, while the unemployment rate climbed from 5.0% in December 2007 to 9.5% by June 2009, and peaked at 10.0% by October of the same year. Long-term unemployment also rose to historic highs during the same period.

Economic crises such as the Great Recession are disruptive for firms across industries, markets, and geographies. Crises of this magnitude trigger discussions about fundamental issues of strategy and radical organizational change since they are typically associated with periods of significantly greater uncertainty (Bloom 2014), changes in the regulatory and policy framework (Baker et al. 2013, Pastor and Veronesi 2012, Rodrik 1996), higher cost of capital and tightened access to external sources of credit (Chodorow-Reich 2014), disruptions in supply chains (Cattaneo et al. 2010, Levy 1994), deteriorating consumer demand (Mian et al. 2013), and increased risk of firm failure (Bernanke 1981, Bhattacharjee et al. 2009).In short, an economic meltdown leaves virtually no aspect of firms’ business environment unaffected, disrupts their stakeholder relationships (such as relationships with employees, customers, suppliers, and local communities), and generates a major shift in the competitive landscape. Thus, companies need to fundamentally rethink and reshape their strategies to ensure firm survival and sustain (or even enhance) their competitiveness.

Despite the severity and frequency of economic crises, we know surprisingly little about their impact on firm-level decision-making and, in particular, on firms’ competitive strategies (e.g., Bromiley et al. 2008). This is a significant void in the literature, given that all firms are subject to the macroeconomic business cycle, and that managers likely face multiple recessions during their careers. Firm strategies need to strike the right balance between the development of sustainable competitive advantage in the long-term on the one hand, and the adaptation to short-term disturbances in the business environment on the other. While the adaptation to external changes has long been a focus within strategic management research, the spotlight has been on relatively incremental changes or changes within a specific industry (e.g., Christensen 1997, Eisenhardt and Martin 2000, Helfat et al. 2007, Meyer 1982, Teece et al. 1997). In contrast, the critical issue of firm strategy in times of major shocks—shocks that adversely impact multiple industries and economies simultaneously, disrupting the entire business environment—remains largely unexplored (Agarwal et al. 2009, Garcia-Sanchez et al. 2014).

In a first effort to fill this gap in the literature, we investigate changes in companies’ investment strategies in recessionary times. More specifically, we theorize and empirically examine whether and in which direction firms adapt their strategic investments in human capital, physical capital (tangible), and organizational capital (intangible) resources, all of which are identified in the existing literature as critical strategic firm resources in the context of long-term value creation (Barney 1991).

Whether firms should cut or increase strategic investments is not a priori obvious given that a disruptive shock to the business environment presents firms with both challenges as well as opportunities.On the one hand, an economic downturn may impair firms’ ability to undertake investments in key strategic resources (e.g., due to declining revenues, increased market uncertainty, higher cost of capital, and tightened access to the credit market). As a result, they may lay off employees, postpone expansion and infrastructure projects, liquidate assets, delay R&D projects, or eliminate corporate social responsibility (CSR) programs to maintain cash flows. In other words, firms may try to save their way out of recession. On the other hand, economic downturns can also represent an opportunity for firms to expand investments, i.e., to invest their way out of recession. For example, a recession might generate opportunities to acquire new or expand existing assets at lower cost―given that asset and equity prices typically fall during recessions―or opportunities to hire employees at lower wages (Bils 1985, Solon et al. 1994). Firms can also invest in innovation to strengthen their competitiveness for when the economy recovers and consumer demand picks up again. Similarly, investing in CSR programs during trying times may enable firms to strengthen their stakeholder relations, thus improving organizational resilience during as well as after such recessionary periods.

Anecdotal evidence abounds with examples of companies cutting investments in human capital and tangible resources while sustaining their investments in intangible resources―such as innovation and stakeholder relations―during economic crises. In fact, while many U.S. companies cut jobs and wages, they continued spending on innovation (Wall Street Journal 2009a). A survey of 290 senior executives and R&D leaders confirms the vital role of innovation in corporate strategy during recessions (Booz & Company 2009). To remain competitive and in an attempt to improve a firm’s competitiveness, the majority of surveyed companies sustains—or even boosts—investments in R&D. For example, Harman International, a $3 billion maker of high-end car audio and infotainment systems, aimed to “emerge leaner, more efficient, and more technologically capable” (Robert Lardon, Booz & Company 2009, p. 11) from the downturn. Similarly, many innovative products from Apple’s iPod to General Electric (GE)’s fuel-efficient aircraft engines resulted from investments during economic downturns (Wall Street Journal 2009a).

Relatedly, many large companies, including GE, IKEA, Intel, Microsoft, Rio Tinto, Starbucks, and Wal-Mart maintained their investments in CSR programs during the recent recession (Boston Consulting Group 2009, Fortune 2009). For example, despite the economic slump, GE continued its investments in CSR programs, including citizenship efforts across the globe, the development of environmentally friendly practices and products such as solar panels, clean-coal power plants, etc. (Fortune 2009). A similar approach is taken by Starbucks whose CEO Howard Schultz stated during the crisis, “Now is a time to invest, truly and authentically, in our people, in our corporate responsibility and in our communities. The argument—and opportunity—for companies to do this has never been more compelling” (Huffington Post 2008). Intel’s chairman, Craig Barrett, echoes the view that strategic investments in people and environment cannot wait and that stakeholder relations cannot be put on the back burner; as he puts it in a nutshell, “You can’t save your way out of recession—you have to invest your way out” (Fortune 2009).

Drawing from different strands of literature, we theorize that sustaining investments in intangible strategic resources—such as innovation and stakeholder relationships—in recessionary times is of particular importance to maintain, or even enhance, firms’ competitiveness. Specifically, we theoretically argue that a strategic focus on these resources can help companies sustain their competitiveness by enabling them to i) become more efficient and innovative, ii) adapt more easily to shifting needs and demands of suppliers, consumers, and other stakeholders, and iii) enhance organizational resilience. For example, by investing in R&D projects in a time of crisis (and therefore, in a time of scarcity), companies may find innovative ways to become more efficient, i.e., to do more with less. Relatedly, existing research finds that through experimentation companies are better able to adapt quickly to changes in the business environment (e.g., Eisenhardt and Martin 2000) and improve their technological capability. Moreover, information, communication, collaboration, and stakeholder orientation are important factors in the innovation process (e.g., Eisenhardt 1989, Eisenhardt and Martin 2000, Flammer and Kacperczyk 2015). Accordingly, we argue that the stronger the firms’ stakeholder relationships are, the better positioned firms are to understand changing situations in times of crisis, identify concerns and opportunities, and adapt to shifting needs and expectations of various stakeholders. Furthermore, firms with superior stakeholder relations are more likely to benefit from, for example, lower price elasticity of demand and higher consumer loyalty (e.g., Du et al. 2007, Kotler et al. 2012), enhanced attractiveness as employer (e.g., Turban and Greening 1996), reduced risk of social activism and regulatory action (e.g., Baron and Diermeier 2007, Maxwell et al. 2000), and lower capital constraints (Cheng et al. 2014). Hence, we propose that exhibiting leadership and commitment towards stakeholders can help companies improve their organizational resilience through such mechanisms and, as a result, companies would be able to maintain or even enhance their competitiveness during the downturn. In line with these arguments, we posit that companies react to macroeconomic meltdowns by strategically sustaining their investments in innovation and stakeholder relationships.

As discussed, to date, the important question of whether firms save or invest their way out of economic crises has been neither theoretically nor empirically addressed in the literature. From an empirical perspective, this question is particularly difficult to answer given that all companies are affected (i.e., “treated”) by a recession; thus, there is no natural “control” group that provides a counterfactual of how companies would have behaved had they not been affected by the recession. Studying the Great Recession helps overcome this empirical challenge. An important feature of the Great Recession—and one that makes it particularly suitable for academic studies—is the role played by house prices. Regions in which the house price collapse was more severe (and hence where a larger fraction of households ended up with negative home equity) experienced a larger drop in households’ purchasing power, leading to a larger drop in consumption (Mian and Sufi 2011, 2014, Mian et al. 2013). Therefore, the severity of the house price drop provides cross-sectional—more precisely, regional—variation in the severity of the crisis. This cross-sectional variation can be used to study how firms that are more severely affected by the recession (i.e., firms located in regions that experience a larger drop in house prices) adjust their strategic investments compared to firms that are less affected. In principle, this methodology is similar to a difference-in-differences approach in which we would compare the strategic investments of firms in more affected regions (“treatment group”) with those of firms in less affected regions (“control group”). Using this methodology, we examine how the drop in house prices affects firms’ investments in key strategic resources. These are typically classified in the literature as human capital, tangible, and intangible resources (Barney 1986, 1991). Accordingly, we consider a) the size of the workforce to capture changes in human capital, b) capital expenditures to capture changes in tangible resources, and c) R&D and CSR investments to capture changes in intangible resources.

Our findings indicate that during the Great Recession, companies significantly reduced their workforce and capital expenditures. Yet, and this is a remarkable finding, they maintained the same level of investments in R&D and CSR. Referring to the opening quote of our study, this result is a “non-barking dog”―i.e., the interesting finding is not so much what companies did, but rather what they did not do: they did not cut back on R&D and CSR investments, despite the cost-cutting pressures and other disruptions that are inherent in periods of recession. Consistent with our theoretical arguments, these findings suggest that intangible resources such as innovation and stakeholder relations are instrumental in sustaining a competitive advantage during and after recessionary times.

A potential concern with our empirical approach is that changes in house prices might be endogenous with respect to firms’ strategic investments—i.e., unobservable variables may drive both changes in house prices and changes in investment strategies. To address this concern, we use an instrumental variable (IV) approach, whereby we instrument changes in house prices with Saiz’ (2010) topological measure of housing supply elasticity. The intuition is that in regions where it is difficult to build new housing (e.g., due to steep hills or rocky terrain), housing prices are more likely to be sensitive to changes in housing demand. Importantly, the region’s topological features are unlikely to be systematically related to firms’ strategic investments. We find that all our results hold when we use this IV approach.

In auxiliary analyses, we further document that―although on average firms do not cut their investments in R&D and CSR―firms operating in less R&D-intensive and less CSR-sensitive industries, respectively, are more likely to do so. This result is intuitive, yet it offers additional verification for the mechanisms we argue for in our study. For example, in less R&D-intensive industries, firms’ competitiveness is less likely to depend on their innovative capabilities. Similarly, CSR is less likely to enhance competitiveness in industries in which CSR engagement is less salient. Finally, we examine whether companies that sustain their investments in R&D and CSR perform better once the economy recovers, and we find that they do. Specifically, they achieve higher operating performance—as measured by the return on assets (ROA) and net profit margin (NPM)—in the post-recession years (2010-2011).

Overall, our findings show that companies sustain their investments in intangible strategic resources such as innovation and stakeholder relations during economic downturns, suggesting that such investment strategies contribute towards the firms’ ability to strengthen their competitiveness during economic crises (and after recovery). In the following, we develop the theoretical arguments in detail, describe the methodology, present the empirical results, and conclude.


[1] The National Bureau of Economic Research (NBER) defines a recession as a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

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