Input Price Shocks and Investment: Evidence from OEMs

Abstract

This paper studies changes in managers' investment decisions in response to short-term cash flow shocks. Using the novel setting of the 1999 Taiwan earthquake and a difference-in-differences design, I find managers reduce investment in research and development (R&D), but not capital expenditure, following the shock. The earthquake increased production costs for a subset of firms in the US high-technology industry that source raw materials from Taiwan. Because the shock occurred in Taiwan and was unexpected, this setting allows me to hold constant market demand and the investment-opportunity set, reducing concerns that changes in demand or investment opportunities could be driving the cutback in R&D. I also provide evidence suggesting the reduction in R&D is related to reduced innovation. Finally, using a decision tree model, I find evidence consistent with an earnings management motive. Specifically, I find firms affected by the shock become more aggressive in revenue recognition.