Intellectual Capital and Financing Decisions: Evidence from the U.S. Patent Data

Abstract

This paper develops a real options model of capital structure to understand two distinct roles played by intellectual capital in corporate financing decisions. First, intellectual capital limits a firm's debt capacity because of its low liquidation value. Second, intellectual capital enhances a firm's debt capacity through its positive impact on the earnings dynamics. We show that the former is dominated by the latter within our model so that intellectual capital positively affects leverage as measured by market leverage, book leverage, and interest coverage ratios. Using three patent-based variables as proxies for intellectual capital, we find robust evidence that a positive relationship between a firm's intellectual capital and its leverage ratio prevails. The effect of intellectual capital on leverage is also economically significant. Specifically, a one-standard-deviation-increase in the level of a firm's intellectual capital increase its market leverage ratio by 11.7-27.3% from the sample mean level (22.2%). We further find that the positive relationship between intellectual capital and leverage is much stronger for high-tech firms than for non-high tech firms. Finally, we document evidence that an increase in intellectual capital leads to an increase in firm leverage over time.