Investment irreversibility and cyclical adversity: Implications for the financial performance of European manufacturing companies

Abstract

This investigation shows how the irreversibility constraints of fixed tangible investments conditioned on the debt flows and financial standing of a company affect its financial performance in cyclical adversity. The System General Method of Moments (GMM) estimator evaluates the endogenous link between the investment-financing flows of companies and the risk-adjusted returns on assets and invested capital. The detrimental effects on financial returns stem from the ill-fated timing of irreversible or partially irreversible fixed tangible investment and arise for companies when there is a deep cyclical gap in real value added, where this adverse effect is particularly strong under concomitant high uncertainty in producer prices.