Research and/or Development? Financial Frictions and Innovation Investment

Abstract U.S. firms have reduced their investment in scientific research ("R") compared to product development ("D"), raising questions about the returns to each type of investment, and about the reasons for this shift. We use Census data that disaggregates "R" from "D" to study how US firms adjust their innovation investments in response to an external increase in funding cost. Companies with greater demand for refinancing during the 2008 financial crisis made larger cuts to R&D investment. This reduction in R&D is achieved almost entirely by reducing investments in basic and applied research. Development remains essentially unchanged. Although patenting is more strongly correlated with development than research investments, the impact of the crisis appears in citation-weighted patent output after 3 to 5 years. Finally, we show that if other firms patenting similar technologies are exposed to the crisis, then a focal firm's Development investment declines. We consider several mechanisms that could explain these results, and without ruling out every alternative, conclude that the overall pattern is consistent with an important role for technological competition in R&D financing decisions