We investigate how firms adjust human capital investments (HCI) in response to performance declines by integrating insights from the behavioral theory of the firm (BTOF) and prospect theory. We propose and find a curvilinear relationship between magnitude of performance decline and changes in HCI: firms experiencing moderate declines adopt risk-averse strategies, reducing HCI to preserve financial stability, while those facing severe declines take risk-seeking actions, increasing HCI to enable transformational recovery. These patterns are moderated by financial leverage, industry munificence, and product strategy change. Firms with higher financial leverage or operating in low-munificence industries exhibit stronger tendencies to increase HCI during severe declines. Similarly, firms pursuing product strategy change demonstrate greater HCI increases compared to those maintaining the same strategy. Our findings contribute to strategic human resource management (SHRM) and resource management literatures by uncovering the contingent and dynamic nature of firms’ HCI responses to performance decline and the role of contextual factors in shaping these decisions.
