An empirical analysis of the curvilinear relationship between slack and firm performance

Abstract

This study performs an in-depth analysis of the curvilinear relationship between slack and future firm performance. Using a sample of US firms, we analyze the influence of three indicators of absorbed and unabsorbed slack on the two commonest dimensions of firm performance: profitability and sales growth. Although the relationship between most slack variables and firm performance is curvilinear, the inflection points (for both maximums and minimums) lie mainly outside the distribution range of the slack variables and, consequently, the curvilinear relationships between slack and performance are, in fact, neither U-shaped nor inverted U-shaped. Therefore, the influence of slack on performance can be positive or negative: linear for certain variables, but concave/convex for most variables analyzed in our study. An additional important finding is that the influence of slack on future profitability is usually the opposite of its influence on future sales growth: negative and positive, respectively, for absorbed slack; positive and negative, respectively, for financial slack. Results are robust to different lagged periods of the independent variables. The effects of equity and cash slacks on future performance are mainly negative, especially for longer time periods.