Unlike the case discussed above, there isan argument that financial slack is strongly associated with inefficiency regarding investment projects that do not yield value forshareholders, which in turn lead to poor firm performance. For instance, if firmswith surplus slack become satisfied, too optimistic and feel less obliged tomake investments in Research and Development, the way of allocation offinancial slack for investments is subject to the philosophy and interests ofthe owners, which may even be conflicting, and it can be considered that thelack of resources is not the hindrance of entrepreneurs.
Moreover, resource constraint theorists argue that slack reducesentrepreneurial creativity (Baker and Nelson, 2005, Mosakowski, 2002). Likewise, (Zona (2012), Debruyne et al., 2010) argued that the existence of excess financial slack can providepoor performance by protecting the company from external shocks, making managers believe they are able toreact effectively to competitive pressures, favoring the managerialaccommodation and irrational optimism, but also make them less motivated to doand leading inadequate implementation of strategies.
Previous empirical studiesdiscussed this opposing views in argument of an inverted U-shaped relationshipbetween financial slack and firm performance. Particularly, the performancebenefit of financial slack as supported by behavioral theorists, increase rapidly with slack, but then level off as there are too many valuable opportunities out therewhich entrepreneurs can look for (Nohriaand Gulati, 1997, Hambrickand Finkelstein, 1987). According to Nohria and Gulati (1997), the costs of slack are limited when slack is low, but start torise quickly when slack gets beyond a certain level and the net effect of thesetwo ways, an inverted U-shaped relationship, suggests that holding an optimumlevel of slack is best in any organizational setting. Slack resources, however, do not deed themselves and simplyholding resources is not enough to create value out of those resources (Sirmonet al.
, 2007) and previous studies documented the relationship betweenfinancial slack and firm performance by investigating when, where, and howthese resources impact performance. With this regard, we reviewed the previousempirical investigation in accordance with the type of relationship studies thatslack and performance have, that is, we organized literatures based on positive, negative and U-shapedrelationship of financial slack and firm performance as follows. Several studies documented positive relationship betweenfinancial slack and frim performance. For instance, Vanacker et al.
(2013) taking venture capital and angel investors as moderator on therelationship of slack and performance, found robust positive relationshipbetween financial slack and firm performance in Venture capital-backed firmswhen investors hold high ownership risks. Similarly, Picolo et al. (2017) using the gross profit margin of Brazilian and Chilean firms asmeasure of financial slack, documented that high discretionary financial slack exhibitednegative extent and a positive association with the financial resources demand,and indicated that firms become inspired in new investments and in strategicchoices when there is financialresources are highly demanded. Argilés-Bosch et al.
(2016) investigated the impact of absorbed and unabsorbed slack onfirms’ performance and documented that unabsorbedslack has a more promising effect on future firm performance than absorbedslack, that is, the measure of absorbedslack indicators used in their study (theratio of inventory to sale, of property, plant and equipment to sale andselling, general and administrative expenses to sale) found to besignificantly and negatively associated with firms’ forthcoming performance, the andall indicators of unabsorbed slack (financial slack, equity-debt slack and cashslack)found to have positive, negative, and non-significant influences,respectively. The evidence documented in their study has implication forresource redeployment by suggesting that firms choose to withdraw resourcesfrom existing business and redeploy them to cultivate new and more promisingbusiness opportunities. The empirical investigation of the importance of slack for neworganizations facing ‘tough’ environments (Bradley et al., 2011), reveal financial slack enhancing capacity(in hostile and dynamic environments), that is the strong positive correlationbetween slack and performance for new firms was in low discretion environments(hostile and stable environments). Also, Marlin and Geiger (2015), on the basis of aconfigurational approach, examined the relationship between organizationalslack and performance and the study found that configurations with higherlevels of slack outshine those with lower levels of slack signifying positiveassociation between financial slack and performance. To the contrary, severalprevious studies found inverse relationship between financial slack and firmperformance. Shahzadet al.
(2016), by considering slackheterogeneity (human, financial and innovational slack), they investigated theslack resource-corporate social performance relationship of US firms. Theresult of their study supported the agency theory view of negative relationshipbetween financial slack and corporate social performance. Empiricalinvestigations also found a unique relationship between financial slack andperformance which is called curvilinear or inverted U-shaped. For instance, Tan (2003)investigated the curvilinear relationship between financial slack andperformance of Chinese firms and the result confirmedthat the relationship between the two variables (financial slack andperformance) is hardly linear.
This study also suggested that the firm shouldhave an optimum level of slack, as denoted as the peak, then after, the cost ofslack curdles the relationship between slack and performance, that is up tosome level, slack can be a basis of competitive advantage, that enables thefirm to chase high-variance opportunities while handling downside insecurity;beyond the critical point, slack becomes a value-destroying force. Furthermore,(Tan and Peng, 2003), investigated the financial slackand Chinese firm performance and they depicted that organizational theoryprovide strongly predicted when dealingwith unabsorbed slack and agency theory offers strong support concerningabsorbed financial slack of Chinese firms and, they found curvilinear relationshipbetween financial slack and firm performance. (George, 2005), using the sample of privately ownedfirms; using high discretion, low discretion and transient category offinancial slack, documented inverse U-shape for low-discretion slack toperformance relationship, positive and linear relationship of high discretionslack and performance and positive and concave relationship of transient slackand privately owned firm performance. Kim et al.
(2008) ,Wiersma (2017b),Danneels (2008),also are among others, who investigated the relationship between financialslack and firm performance and documented the inverse U-shaped or curvilinearrelationship.