What Finances R&D? R&D, Capital Investment, and Financial Constraints

Abstract

I employ a dynamic multi-equation model in which firms make interdependent financing and investment decisions under the constraint that sources and uses of cash must be equal. In this setting, R&D-cash flow sensitivities for young and mature high-tech firms are both small and indistinguishable from each other. Financing-cash flow sensitivities highly dominate investment-cash flow sensitivities. Therefore, contrary to the results in prior literature, I find little evidence that high-tech firms cut back R&D due to financial constraints. I argue that the big significant R&D - cash flow and equity issue sensitivities for young high-tech firms found in prior research are mostly due to failure to control for accounting identities. My results also indicate the presence of heterogeneities between young and mature high-tech firms in the sources of finance for R&D and the interaction between R&D and capital investment. Overall, results are consistent with the notion that young firms finance R&D through internal and external equity, while mature firms use cash flow and debt for R&D financing. R&D and capital investment are highly positively correlated for mature, but not young, firms.