We study how firms engaged in both R&D and fixed investment manage liquidity and adjust real investment during the recent financial crisis. Among firms with positive R&D expenditures, cuts to fixed investment in the crisis are typically far more severe than cuts to R&D. These firms allocate cash reserves to buffer R&D but do not use cash to protect fixed investment. Some firms appear to go so far as to allow the stock of fixed assets to fall to stabilize R&D. The use of cash holdings and fixed assets to protect R&D is particularly strong among firms most likely to face financing frictions at the start of the crisis. We only find evidence that firms use cash to buffer fixed investment when we expand the sample to include firms with no R&D spending to compete for funds. Our study provides direct evidence on the real effects of liquidity management, highlights a key benefit of precautionary cash reserves, and illustrates the adjustments firms make to navigate a financial crisis.

We examine whether short sellers identify firms that have significant changes in default likelihoods and credit rating downgrades. In the month before a rating downgrade, equity short interest is 40% higher than one year prior. Short sellers predict changes in default probabilities that lead to downgrades by focusing on firms with inaccurate or biased ratings. This strategy is profitable for short sellers primarily since downgrades are associated with significantly negative equity returns. Short sellers also facilitate price discovery by reducing abnormal stock returns following downgrades and by leading bond yield spreads.