A recent HBS study of seven downturns in the last three decades affecting 600 North American and Western European companies led to some interesting conclusions for instructions for surviving firms to plan for the future. The most basic and general amongst these is that companies can - and should - take action during good times to protect themselves and their stakeholders from a disastrous loss of value.  More specific observations were as follows:

  • Firms with many ordinary shareholders tend to recover better from softenings than do firms that have just a few big investors. Reason being that strategic investors typically do not trade their stock. Therefore, equities with high levels of "free float" - the proportion of shares publicly traded among ordinary investors - are more liquid and more susceptible to short-term price fluctuations. Bad news sends them down quickly, good news has a similarly rapid effect. The lesson being that management teams need to resist the siren call of selling to strategic investors, otherwise they jeopardize recovery from future softenings.
  • Structuring the firm's offerings to increase margins before the next downturn strengthens the company's prospects to survive. Across downturns, companies with above-average margins recover a higher percentage of their pre-downturn price-to-earnings level, compared with those with below-average margins. Companies should avoid developing portfolios concentrated in low-margins businesses, or should at least balance such portfolios with higher-margin businesses that are more resilient during downturns.
  • Diversification is key. This includes revenues from a geographical spread, for instance North American companies earning revenue in Asia and the Middle East. It could emerge as an effective way to diversify sources of funding and spread risk.
  • Establishing a capital cushion. Creating a sizeable buffer comes with significant costs, but a pre existing above-avergae level of capitalization in the company softens the valuation effects of downturns.
  • Avoid changing the firm's governance structure during the downturn. Either combining or splitting the roles of CEO and chairman has negative effects, whereas maintaining the structure significantly protects firms from value reductions.
  • Avoid discontinuing dividends. Firms that regularly distribute dividends seem to be relatively insulated from reductions in value during ordinary downturns - unless they are forced to go to extremes to raise the necessary funds.
  • Avoid increasing a poorly capitalized firm's capital level during the downturn. The stock market tends to view such a move as a sign of distress.Of course, most firms tend to react more quickly during the downturn, and structural changes are difficult to implement during boom periods when competitors are juicing up the bottom line by participating in high-risk activities that create revenue. But having strategies that at least build in an expectation of future downturns is critical, and executives need to examine the potential negative effects that their business decisions and models will have on the company's valuation during and after the next slowdown. In other words, firms don't need to stop dancing , but they do need to be ready for the moment when the music comes to a sudden and horrifying stop.
    Condensed from the Harvard Business Review, Dec 2008