Institution Matters: Reexamining the Performance Feedback-R&D Expenditure Relationship in China

Abstract

We examine how negative performance feedback and institutional context jointly influence a firm’s R&D expenditure. For firms whose performance is below the aspiration level, increasing R&D expenditure is attractive because it facilitates organizational change. However, at the same time, R&D activities tend to improve performance in a long-term and are very costly, and poorly performing firms are often concerned more about short-term performance and face financial constraints. We propose that, in weak institutions such as China, poorly performing firms reduce R&D expenditure because the weak institution would make firms more short-term-oriented and exacerbate the financial constraints problem. Furthermore, while state ownership and provincial economic growth rate enable Chinese firms to invest more in R&D in the presence of negative performance feedback, strong provincial IPR regime would reduce the firm’s R&D expenditure further.