The effect of cash reserves on corporate investment and performance in industry downturns

We investigate whether large cash reserves are beneficial in industry downturns. In a sample of firms from industries experiencing a substantial decline in sales growth, we find that firms with greater cash reserves invest more during and immediately following the downturn, and that cash reserves reduce the direct effect of the sales decline on investment. Further, we find that the ability to continue investing during a downturn is beneficial, resulting in better operating performance and post-downturn sales growth. In a control group of industries not experiencing downturns, cash reserves also contribute to increased investment, but this investment reduces performance. We conclude that in non-downturn periods, cash reserves are harmful in that they lead to overinvestment, but that their effect reverses in downturns, when they provide a beneficial source of internal financing for continued investment.