Financial Constraints and High Level of R&D

This section examines the effects of internal funds, equity financing, and market timing on R&D by classifying firms as financially constrained and unconstrained, and as high R&D and low R&D firms.

Table 5 presents the results for financially con­strained and unconstrained firms with 2 models each. First model uses variable EqFin 1, and the other model uses EqFin 2. The last part of the table covers the results for the entire sample. For

Table 5. Financial constraints and high level of R&D

Table 5.

Robust standard errors are in brackets.

financially constrained and unconstrained firms, the analysis first examines if the effects of all variables are the same between two sub groups. Then, the effect of high level of R&D is combined with the effect of financial constraints. Interaction variables between High R&D and Cflow, EqFin 1 and EqFin 2 are used to investigate this issue.

Comparison of model 1 between financially constrained and unconstrained firms shows that the sensitivity of internal funds is higher for financially unconstrained firms. Even though the estimated coefficients of Cflow are insignificant for both groups, the coefficient of SqCflow of constrained firms (0.117) is lower than that of unconstrained firms (0.352). Moreover, in unreported results, the sensitivity of equity financing for financially constrained firms (0.032 for EqFin 1 and 0.042 for EqFin 2,) is higher than that of financially unconstrained firms (-0.004 for EqFin 1 and 0.004 for EqFin 2). The coefficients of mispric­ing variable (AdjMtoB) are higher for financially constrained firms than financially unconstrained firms for whichever equity financing variable is used. These results indicate that firms with insuf­ficient internal funds use more equity financing to increase their R&D investment a year after favorable market conditions.

We also investigate how the sensitivities occur in case of high R&D expenditures for both financially constrained and unconstrained firms. The coefficient of the interaction variable (HighRD*Cflow) is negative (-0.112in model 1

and -0.103 in model 2) for financially constrained firms. The combination of this interaction vari­able and Cflow itself indicate that the U-shaped effect of internal funds is only relevant for firms with high level of R&D expenditures if they are financially constrained. This is not true for fi­nancially unconstrained firms. The coefficients of the same interaction variables are positive (0.043 and 0.021).

The coefficients of the interaction variables between High RD and equity financing (High RD*EqFin 1 and High RD*Eq Fin 2) for finan­cially constrained firms (0.067 and 0.062) are higher than those for financially unconstrained firms (0.014 and 0.015). The combinations of these coefficients with the coefficients of EqFin1 and EqFin 2 show that financially unconstrained firms with high level of R&D also finance their R&D investment by equity, but not as much as financially constrained firms do. This evidence indicates that the dividend payment is a proxy for both internal and external financial constraints. For financially unconstrained firms, it implies that they have sufficient internal funds to use in R&D investment (positive effect of internal funds), but have restrictions to raise external financing and therefore, they do not use new equity financing to finance their high level of R&D expenditures.

The interaction variables between High R&D and AdjMtoB for both financially constrained and unconstrained firms shows that both type of firms use market timing opportunities, as the coefficients of the interaction variable (High RD*AdjMtoB) are positive and significant.

The last part of Table 6 provides the results for the effects of internal funds, equity financing and mispricing for firms with high portion of R&D expenditures in total assets in the entire sample. Investigation of the three interaction variables, High RD*Cflow, High RD*EqFin 1 in model 1 (High RD*EqFin 2 in model 2), and High RD*AdjMtoB, shows that the U-shaped effect of

Table 6. The importance of economic system

Table 6.

Robust standard errors are in brackets.

internal funds, higher R&D investment with more equity financing and high market valuation are relevant for firms with high R&D expenditures.