Financial market imperfections and sensitivity of cash holdings to R&D investment: Evidence from chinese listed firms

Abstract

Previous studies on developed economies have shown that firms with more research and development (R&D) activities tend to hold more cash. In a transitional economy, such as China, where financial market imperfections prevail, the likelihood of firms reserving cash for R&D is even higher. This study identifies two alternative credit financing channels, equity state-ownership and bank connection, that can be used by Chinese listed firms to raise external funds and mitigate the market imperfection problem. Typical external financing facilitation channels (EFFCs) effectively mitigate financial constraints through reducing information asymmetry between firms and creditors, alleviating R&D dependence on cash holdings. However, as China’s financial reform deepens, market environment improvement weakens the EFFC effect. Hence, this study deliberates on the mechanisms by which the EFFC effect may be reduced, leading to useful policy implications for financial market reform in China to abate innovation costs.