R&D based knowledge capital and future firm growth: Evidence from China’s Growth Enterprise Market firms

Abstract

Building upon a dynamic stochastic general equilibrium (DSGE) model, this paper examines the role of knowledge-based capital (KC) in improving firms’ future growth in productivity. Based on the analysis of Chinese listed firms from 2006 to 2017 in the Growth Enterprise Market (GEM), we find KC often generates endogenous movements in productivity and earnings over the business cycles, suggesting that the nature of KC is pro-cyclical. Moreover, investment in KC is often classified as a corporate expense and is thus deducted from the current year’s profits. Therefore, firms with high R&D investments have significantly higher future productivity growth but lower current profitability than do those with lower R&D investments. Given these characteristics, KC’s benefits to productivity and future earnings are thus not immediate. For faster growth in the long term, firms should continue investing in KC even if they may face a short-term fall in corporate earnings as a result of internal knowledge investment, especially for fast-growing GEM firms.