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.

We exploit the 1996 telecommunications deregulation as a quasi-natural experiment to investigate whether incumbents alter debt and capacity tactics when facing new rivals. We find that incumbents increase leverage after deregulation, even when controlling for traditional determinants and market conditions. Consistent with a new post-deregulation benefit, a higher leverage is positively related to market shares. This behavior appears only in telecommunication segments most affected by the deregulation. We find weak evidence for increased use of capacity tactics. Our findings for incumbents facing an influx of rivals in a rapidly expanding market differ from those of earlier studies considering mature markets.