Recession risk fluctuates substantially “before the storm,” yet little is known about how firms of different sizes adapt their policies accordingly. We embed time-varying recession risk into a model of liquidity management and investment, allowing firms to time their precautionary policies. Estimation reveals that small firms are less sensitive than large firms in their issuance, payout, and investment strategies to variations in recession risk. This is because small firms proactively build larger cash reserves relative to their current cash flow volatility during periods of low recession risk, anticipating that aggressive investment will gradually drain liquidity, grow cash flow volatility, and raise the risk of liquidation if a recession occurs. In contrast, large firms rely on robust cash flows to replenish liquidity during periods of low recession risk, deferring other precautionary actions until recession risk intensifies. These results have important implications for estimating the impact of recessions and macroprudential policy. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.08861 .
Kakhbod et al. (2026) studied this question.