Effects of unexpected financial slack on SMEs’ diversification and growth: evidence from China

Purpose - The purpose of this study is to investigate the relationship between unexpected financial slack and small- and medium-sized enterprises’ (SMEs) diversification and growth performance. Design/methodology/approach - Using the phenomenon of IPO over-financed in China as the empirical context, the authors constructed a firm-level measure of unexpected financial slack based on over-financed capital resources and extended the nascent inquiry on unexpected slack. Findings - The authors proposed and tested that, with unexpected slack obtained from IPO over-financed, SMEs did not engage in diversification until slack was extraordinarily high (a curvilinear relationship). And in such cases, SMEs preferred geographic diversification rather than industry diversification. Moreover, SMEs were able to sustain growth performance both in the short term and in the long term. Practical implications - This study had important implications for regulators and managers. The findings of this study suggested that proper regulations on usage of over-financed capital helped SMEs’ sustain their growth performance. Regulatory policies could curb managers from cognitive biases to behave more prudently and deploy the resources more consciously. However, with sufficient resources, managers should also consider more explorative growth drivers such as diversification. Originality/value - This study joined the efforts of extending the antecedents of slack formation from internal managerial behaviors to external uncertain factors. As the first study to explore the role of unexpected slack at firm level, the results of this study shed more light on the effects of unexpected slack resources.