Investment and internal funds of distressed firms

The investment-cash flow sensitivity literature excludes financially distressed firms because their investment behavior is presumably different from that of healthy firms. First, we find that the investment behavior of distressed firms with operating profits is similar (positive sensitivity). Second, distressed firms with operating losses typically invest less than the previous year. They downsize regardless of cash flows (near-zero sensitivity). Finally, 40% of the time distressed firms with operating losses invest more than the previous year. They surprisingly invest more when cash flows are lower (negative sensitivity). The investment is funded by equity holders, consistent with a gamble for resurrection.