ASYMMETRIC EFFECTS OF THE BUSINESS CYCLE ON FIRM-FINANCED R&D

Authors: Rafferty, Matthew¹; Funk, Mark²

Source: Economics of Innovation and New Technology, Volume 17, Number 5, 2008 , pp. 497-510(14)

Publisher: Routledge, part of the Taylor & Francis Group

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Abstract:

Business cycles might affect the ability of firms to finance R&D, since firms rely on cash flow to finance most R&D activities. However, business cycles also influence the incentive to perform R&D. The opportunity cost of funds devoted to R&D falls during recessions, since the return on production will likely be lower than during an expansion. During recessions, this provides firms with an incentive to redistribute an existing pool of funds away from production and towards R&D projects. The changes in the size and distribution of the pool may also be asymmetric across the business cycle. For example, cash-flow constraints are more likely to bind during recessions than expansions. This paper finds strong evidence for the cash-flow effect, but not the opportunity-cost effect. This means that R&D is pro-cyclical, but smoothing out the business cycle will actually lead to reduced R&D, since the duration of expansions exceeds the duration of recessions.

Keywords: Business cycle; R&D

Document Type: Research article

DOI: http://dx.doi.org/10.1080/10438590701407232

Affiliations: 1: School of Business, Quinnipiac University, Hamden, CT, USA 2: Department of Economics & Finance, University of Arkansas, Little Rock, USA

Publication date: 2008-01-01

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