The Interdependence of R&D Activity and Debt Financing of Young Firms

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung der KfW und des ZEW dar.Dis cus si on Papers are inten ded to make results research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the KfW and ZEW. Non-technical SummaryBusiness start-ups and young enterprises introduce new products to the market and employ new processes for production. In order to create these new products and processes, firms often engage in R&D. Since conducting R&D is an expensive task, substantial financial resources are required. However, the internal financing capacity of young firms is limited because young firms generate no or a very low sales volume in the first years succeeding market entry, and no revenue reserves from previous years are available. In the case of limited internal financing, loans can relieve financing constraints on R&D activities. The relationship between R&D activities and loan financing can also be argued to go in the opposite direction. The ability of young enterprises to tap external financing sources depends, among other things, on growth opportunities which may be generated by R&D activities. Moreover, R&D expenditures are rather allocated into intangible assets that cannot serve as collaterals. This reduces a firm's possibility of loan financing.In this paper, we explore empirically the bidirectional relationship between R&D and loan financing. We In a first step, we estimate single-equation models that explain, first, the share of loan financing and, second, firms' R&D intensity, defined as R&D expenditures over total sales. Our estimates reveal that the share of loan financing is basically determined by firm-specific variables derived from traditional theories of corporate finance like static trade-off theory or pecking order theory. Entrepreneur-specific variables only play a subordinate role for explaining the capital structure. On the contrary, both firm-specific and entrepreneur-specific variables are decisive for the level of firms' R&D intensity. In the single-equation models, we find neither an effect of R&D intensity on the share of loan financing, nor an effect in the opposite direction.In a second step, we estimate a simultaneous, two-equation model in order to account for the interdependence of R&D activity and loan financing. Our results show that the coefficient estimates for the exogenous covariates hardly differ between the single-equation models and the simultaneous, two-equation model. However, the two-equation model proves that there is in fact a significantly positive, interdependent relationship between the share of loan financing and R&D intensity. Yet unobserved random shocks are negatively correlated across the two equations...

Building a Model to Assess Signaling Theory in Its Correlation between Capital Structure and Firm Value

“…Therefore, statistically, DER does not have a significant effect on TATO. This study was not in line with the findings of (Fryges et al, 2015), and (Mahendra, 2015) which stated that the use of funding sources from debts can improve firm activities through the improvement of R&D and firm innovation.…”

“…In the signalling theory, it is explained that a company that has courage in using debts as its capital source means that it can optimally use the funding, consequently, the gained earnings will be able to cover the expenses of the use of the debts. The use of funding sources from debts can improve R&D activities (Fryges et al, 2015). The use of debts disciplines the company management and directs it to behave in line with the purpose of the company.…”

Innovation, asymmetric information and the capital structure of new firms

“…Contrasting results about the relative importance of debt are obtained in Fryges, Kohn, and Ullrich (2015) and Brown et al (2012). Whereas Fryges, Kohn, and Ullrich (2015), analysing 2007 German data, find a positive and perhaps two-way relationship between bank debt and R&D intensity, Brown et al (2012) found a negative relationship between hightech firms and the use of bank loans for the period 2007-2009.…”

“…Extant empirical research shows that start-ups are often forced to raise external funds because they lack internal finance (Fryges, Kohn, and Ullrich 2015). Moreover, new firms have to deal with credit rationing due to their higher asymmetric information levels than larger and older firms (Carpenter and Petersen 2002b;Stiglitz and Weiss 1981).…”