R&D Investment and Capital Structure

It is well known that innovative firms tend to issue equity for external finance, but no one has attempted to differentiate whether this is due to financial frictions from the supply side of capital or is voluntarily chosen by firms given that the policy implications are quite different. This paper tries to fill this gap. We first confirm that firms with high R&D investment issue more equity and less debt, have a lower leverage, and tend to become zero-leverage. We also use the introduction of state-level R&D tax credits in the US as an exogenous event to establish the causality. Then we examine corporate financing decisions after firms are granted patents. We find that firms with more favorable patent characteristics issue less debt and more equity, and have a lower leverage. Because patents can reduce information asymmetry associated with R&D investment and be used as collateral, firms ’ tendency to issue equity after credit constraints are partially relaxed shows that frictions from the supply side of capital are not the critical reason for innovative firms to issue equity. Innovative firms may find that equity is conducive to innovation so that they choose to issue equity. JEL Classification: G31, G32