Operating Leverage and Corporate Responses to the COVID-19 Crisis

Managers choose operating leverage by balancing the benefits of low variable costs and greater capacity at times of business growth against the risk of low cost flexibility when faced with a negative revenue shock. We examine how firms’ crisis responses and planning behavior vary with their degree of operating leverage by exploiting the fact that many firms experienced an unexpected negative revenue shock during the COVID-19 pandemic. We find that firms with high operating leverage react more dramatically to revenue declines and are less likely to invest or hire in both the short and medium term. Additional liquidity support in the form of government assistance mitigates this negative effect of operating leverage by reducing investment cancellations and increasing the likelihood of investment in the medium term. By contrast, firms with different levels of operating leverage behave very similarly if they are not facing a sudden drop in sales. The results show that operating leverage is an important determinant of firm flexibility and thus shapes a firm’s resilience and risk profile.