The effect of R&D tax credit on innovation: A life cycle analysis

Abstract

The purpose of this study is to explore how tax credits for research and development influence innovative activity (as measured by investment in R&D) with emphasis on the moderating role of the firms stage in its respective life cycle. Our sample comprised all electronics firms listed on the Taiwan Stock Exchange and Taiwan’s Over-the-Counter Market fom 2002–2007. Our final sample comprised 943 firm-year observations. We ran regressions and our findings indicate that the R&D tax credit has the greatest impact on innovative activity when the firm is in the stagnant stage and the least impact when the firm is in the growth stage. Our contribution to the extant literature in innovation is severalfold. First, in prior studies, the R&D tax credit is measured as a dummy variable. In this study we use actual R&D tax credit data. Second, prior research examining the association between the R&D tax credit and innovative activity has shown mixed results. We provide an explanation for the inconclusive results by showing that the association is contingent on the stage of the firm in its life cycle. This was not addressed in prior studies. From the public policy standpoint, our findings imply that governments should provide companies with increased tax incentives to stimulate innovative activity, especially when companies are in the stagnant stage in their respective life cycle.