RQ and Endogenous Firm Growth

Abstract

R&D has historically been believed to be the engine of firm and economic growth. However the formal link between R&D and growth at the macro level wasn’t explicated until 1990, and it has been even more recently that it has been explicated at the firm level. To date empirical tests have supported the theory at the economy and industry level, but lack of observables has prevented tests at the firm level. Accordingly we develop an analytical model of endogenous firm growth whose propositions match those from the general equilibrium models: R&D expenditures, market value and growth all increase in R&D productivity. We test the propositions using three proxies for R&D productivity: RQ (firm-specific output elasticity of R&D), TFP, and patent intensity. We find all three propositions are supported in tests using RQ, but that this is not true for the other proxies. These results have two implications. First, blanket policies of R&D subsidies are misplaced—rather subsidies should be directed toward firms with higher RQ, or toward increasing firms’ RQ. Second, we recommend caution using TFP and patents when testing theories of R&D investment and outcomes.