Economic downturns disrupt firms’ operations and strategic decisions and impair their financial health. During the recent pandemic, for example, many companies were forced to reduce expenses or lay off employees, driving the U.S. unemployment rate to 14.7 percent in 2020, the highest since the Great Depression. Additionally, the pandemicdestabilized financial markets and caused significant losses for firms that led to widespread liquidity challenges. These effects prompted widespread calls for solutions.

In a new paper, we explore the role of equity financing in supporting firms during the pandemic. Specifically, we examine how receiving equity financing affected stock performance, financial distress, and firms’ pay outs and investment decisions.

We find that there is merit in raising equity during an economic downturn. Firms that did so during the pandemic experienced higher stock performance and lower financial distress compared with non-issuers. Furthermore, we show that issuing equity capital during an economic shock affects firms’ financial decisions. Firms that issued equity during Covid-19 maintained their stock-repurchase, acquisition, and capital expenses and increased dividends and R&D expenses. This is especially important as typically firms need to cut investments and pay-outs when facing economic difficulties.

Our results also indicate that firms issue equity for different purposes depending to the stage of the pandemic. Those that issued equity earlier in the pandemic increased their cash reserves to a greater extent. A potential explanation is that, at the beginning of a pandemic, the length and severity of its impact are largely unknown; hence firms raise equity for precautionary reasons to build a safety net against uncertainty. However, we find that in later months, as the pandemic unfolded and restrictions eased, firms increasingly used equity issuances to support their investment activities, including acquisitions, capital expenditures, and R&D investments.

A particular feature of the pandemic was that its impact varied across industries, with tech firms, for example, adapting more readily to remote work and social distancing measures. However, businesses like hospitality, which rely on physical interactions, suffered more damage from lockdown restrictions. By examining equity issuers across different industries, our findings demonstrate that issuers operating in industries heavily affected by Covid-19 experienced higher stock performance, suggesting that investors were more concerned about firms operating in those industries and viewed the capital infusion as strengthening their ability to withstand the pandemic. Meanwhile, issuers from less affected industries had a lower likelihood of default and utilized the capital raised to increase their dividends and R&D activities. This shows that issuers from less affected industries were in a better position to expand their pay out and investment activities compared with those in more affected industries.

Finally, we illustrate that the level of liquidity obtained from equity issuance matters. We find that the liquidity obtained through an equity issuance during Covid-19 was viewed positively by the market, providing incremental benefits to firms’ stock performance, financial health, and financial decisions.

The results of our study are significant for policymakers as they provide a better understanding of the role of equity raising in alleviating the financial impact on corporations. Specifically, since equity issuance during the pandemic created several benefits for firms, policymakers should consider facilitating the issuing process during periods of economic turmoil. This would enable more firms to acquire capital that could be vital both for their financial condition and corporate decisions. Finally, our findings have implications for society, as poor firm performance and insolvencies resulting from economic downturns can lead to rising unemployment, income loss, and a reduction in household wealth. Attention to our findings by policymakers could help alleviate the negative social consequences of economic shocks.

This post comes to us from Styliani Panetsidou and Angelos Synapis, assistant professors of finance at the Centre for Financial and Corporate Integrity at Coventry University. It is based on their recent article, “Equity financing during the Covid-19 economic downturn” available here.