CONCLUSION

This chapter examines the effects of the financing and past market valuation on R&D expenditures. The analysis also controls the effects of internal funds and patent rights protection.

We find that patent rights protection has a nonlinear effect on R&D intensity. Firms in market-based countries decrease R&D invest­ment as protection index increases. High R&D is associated after a certain level of protection. The effect of patent rights protection index is opposite for firms in bank-based countries.

The analysis supports a U-shaped effect of internal funds for firms in market-based countries. While the sensitivity of internal funds is higher for financially unconstrained firms, the U-shaped effect of internal funds is only relevant for firms with high level of R&D expenditures if they are financially constrained. An alternative and better way to estimate such an existing nonlinear relation would be to employ nonlinear algorithms, which we leave for further research.

Equity financing seems to be well suited for R&D investment. The sensitivity of equity financ­ing is higher for financially constrained firms than that for financially unconstrained firms that have probably sufficient internal funds to use in R&D investment. When the sample covers firms with high level of R&D, financially unconstrained firms also finance their R&D investment by equity, but not as much as financially constrained firms do.

High market valuation encourages future R&D due to low cost of equity. The analysis shows that both financially constrained and unconstrained firms use market-timing opportunities, especially in market-based countries. Firms in bank-based countries; however, there is no effect of past higher market valuation on R&D investment.

We believe that the findings of this chapter help policy makers from different economic sys­tems understand the finance-growth relationship better. R&D expenditures reflect the effect of innovative activities on economic growth. Know­ing the structures of the relationships between internal funds and sufficient external financing and R&D investments should lead to important policy implications in countries where the policy makers pursue higher economic growth.

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KEY TERMS AND DEFINITIONS

External Capital: Funds raised externally by issuing new debt or new equity to invest in capital investment projects.

Financial Constraint: Inability of firms to finance their investment projects by using solely internally generated funds.

Internal Capital: Readily available funds generated by firms from their past operational cash flows.

Market Timing: Managers take actions to get advantages of temporary higher market valuations, such as issuing new shares when past performance of their stocks is better relative to the market or their counterparts.

Pecking Order Theory: The theory for hier­archy in financing. Firms finance their financial needs first with internal cash flows, then with debt, and finally with external equity.

R&D: Research and development expenditure is type of investment on innovation activities to create new products, processes, or services.

Tradeoff Theory: Optimal capital structure is determined by balancing the tax advantages with the agency and bankruptcy costs.

Underinvestment: Managers may reject to invest in some of valuable projects with positive net present values because of agency problems of debt.

ENDNOTES

Brown et al. (2009) find significant effects of internal and external financing on R&D expenditures for young tech U.S. firms. This evidence is sufficient enough to explain the relationship between supply shifts in finance and a significant portion of the 1990s R&D boom and subsequent decline. Martinsson (2010) examines whether R&D spending in Europe in a similar way was sensitive to fluctuations in the supply of internal and external equity during the late 1990s and early 2000s and finds that market-based financial systems outperform the bank­based economies of Continental Europe for providing channel from financing to growth through innovation.

The underinvestment problem is introduced by Myers (1977) who argues that firms with rich growth options should either use short­term debt or reduce their long-term debt, while firms with a stable base of asset-in- place should opt for long-term debt. We argue that this discussion is relevant for regular investments and leads to a conclusion of equity financing being a proper choice for R&D because of its certain characteristics and empirical findings in the literature. We also readdress this issue in the next section

as well.

Worldscope is a database provided by Thom­son financial and contains information on financial data on the world’s leading public and private companies.

This inexistence of statistical difference in the mean of AdjMtoB indicates that mispric­ing proxy is similar between two types of economic system. This does not mean that there is no significant difference in market valuation for firms’ equity in those systems. Unreported results show that the mean of MtoB value is 2.19 for firms in market based countries and statistically significant from the mean value of MtoB, which is 1.40, for firms in bank-based countries.

The numbers of observations change across regression models and basically decrease with including equity financing and market timing variable based on availability of these variables.

Allred and Park (2007) provide a detail dis­cussion for the several aspects of possible negative and positive effects of patent rights protection in developed and developing countries.

This work was previously published in Industrial Dynamics, Innovation Policy, and Economic Growth through Technological Advancements, edited by I. Hakan Yetkiner, M. Teoman Pamukcu, and Erkan Erdil, pages 53-74, copyright 2013 by Information Science Reference (an imprint of IGI Global).