Firms' Financing Dynamics Around Lumpy Capacity Adjustments

Abstract

We study how firms adjust their financial positions around the times when they undertake lumpy adjustments in capital or labor. Using U.S. data from Compustat, we show that there are discernible patterns of financing lumpy adjustment, remarkably similar across capital and labor, but quite distinct between expansionary and contractionary lumpy adjustment episodes. We find strong evidence that both cash and debt capacity are actively manipulated to increase financial flexibility in the years before the ensuing expansion of firm capacity. Debt and cash contribute to financing the investment in capital or labor and leverage continues to rise significantly for two years after the lumpy expansion was initiated. Lumpy contractions are undertaken after years that show reductions in cash balances and above average levels of debt. During and after the contraction, firms rebuild cash and reduce debt growth significantly. These patterns are consistent with firms acting to restore financial health by adjusting their productive operations. We document that lumpy expansions and contractions in capital or employment are systematic time series drivers of firms' leverage and cash balance dynamics.