Capital investments are among the most critical determinants of competitive advantage (Porter, 1992), in that they have long-term implications for firms in their generation of earnings through current and future returns. Because capital investments entail large outflows of cash, they arguably are related to firm returns and its fluctuation. However, the strategic management and financial perspectives often offer different explanations of the relationship between variations in firm returns and capital investments. From a strategic management perspective, variations in cash flow and stock returns should affect the capital investments behavior of firms (Bromiley, 1986a, 1986b), and the integration of behavioral and contingency theories suggest that firms that vary capital investments in response to organizational risk will outperform those that do not. In contrast, the financial perspective indicates that variability in capital investments in response to variability in cash flow is detrimental to the firm's value and should be eliminated, through hedging, to stabilize capital investments patterns (Froot et al., 1993, 1994). Therefore, in this study, our main purpose is to examine the relationships among organizational risk, variation in capital investments, and firm performance.
We also analyze whether the organizational context matters in the relationship between organizational risk and variability in capital investments. Researchers have contended that organizational context strongly influences business investment decisions (Cyert and March, 1963; Thompson, 1967; Noda and Bower, 1996; Steensma and Corley, 2001). Our review of the literature indicates that firms that are more capital intensive, possess more slack resources, and have greater employment variability will behave differently in relation to capital investments than will those with lower capital intensity, slack, and/or variability in employment (Noda and Bower, 1996; Steensma and Corley, 2001). We discuss how these contextual variables may moderate the relationship between organizational risk and variation in capital investments and empirically test the interaction effects. By linking capital intensity, slack, and variation in employment with the risk-variability in capital investments relationship, we highlight the role of organizational contexts for capital investments decisions of the firm.
The major contribution of this study lies in analyzing the organizational risk-variability in capital investments relationship over time using a large sample of pooled time-series data along the following two dimensions. First, we assess whether it is of benefit to the firm to vary its capital investments in response to risk--whether the interaction effect of risk and flexibility of investments on the long-term returns of the firm is positive. This finding has significant implications for researchers, who might further explore the various conditions in which flexible investments improve firm performance, and for managers, who make decisions about capital investments. It also provides insights into when flexibility in investments is undesirable and when managers should act to stabilize investments. Second, we empirically show that the risk-variability in investment relationship is contingent on the organizational context, in that capital intensity accentuates the relationship, whereas slack and variability in employment buffer it. Therefore, managers must be cognizant of the relevant organizational factors that may assist them in making their investment flexibility decisions. In the following sections we discuss the theoretical background, develop hypotheses, explain methodology, and discuss results. We also provide future research directions and managerial implications.
THEORY AND HYPOTHESES
Risk and Variation in Capital Investments
Palmer and Wiseman (1999) refer to organizational risk as the uncertainty of a firm's income stream or returns. …