Creative Destruction and the Bright Side of Economic Downturns

Abstract

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.