Liquidity demand, financing and investment decisions: evidence from the COVID-19 pandemic

Abstract

Purpose This study examines how firms adjust financing and investment decisions in response to the COVID-19 shock, focusing on whether external financing supports investment or preserves liquidity and how these responses vary across firms with different pre-pandemic characteristics. Design/methodology/approach Using data on US public firms, I employ a generalized difference-in-differences framework with firm and quarter fixed effects to identify differential financing and investment responses based on pre-pandemic firm characteristics. I also examine the allocation of external financing to cash holdings and investment, including capital expenditures, acquisitions and R&D. Findings I document that large and positive-cash-flow firms experience greater declines in cash flows, while small and negative-cash-flow firms raise more external capital, particularly through equity. Despite increased financing, firms generally reduce investment: large and high-cash-flow firms cut capital expenditures, while small and negative-cash-flow firms reduce R&D. At the same time, cash holdings increase, suggesting that external financing is used primarily to preserve liquidity rather than fund investment. Overall, the findings indicate that financing decisions during the pandemic reflect precautionary liquidity needs under heightened uncertainty rather than investment needs. Originality/value This study provides new evidence that increased external financing does not necessarily prevent investment contraction during a crisis, highlighting the importance of uncertainty and liquidity preservation in shaping firms' financing and investment decisions. By jointly examining financing, investment and cash holdings, the study provides evidence consistent with liquidity-driven explanations of corporate financing under heightened uncertainty.