Advertisement

R&D Investment timing, default and capital structure

  • Daniela Bragoli
  • Flavia CortelezziEmail author
  • Pierpaolo Giannoccolo
  • Giovanni Marseguerra
Original Research
  • 17 Downloads

Abstract

This paper investigates the interaction between R&D investment timing, probability of default, and capital structure. In particular we are interested in studying the investment behaviour of three different types of firms according to their capital structure: firms that only use internal funds as a source of funding (unlevered), firms that use debt and that are able to attract unlimited amount of funds (levered unconstrained) and finally firms that use debt, but are not able to attract all the amount needed (levered constrained). We consider irreversible investments in R&D with uncertain returns, financed through debt. We show that debt financing (with or without constraints) significantly alters the standard results in the real option literature. First, we show that leverage distorts the investment threshold and shareholders of a levered firm tend to accelerate investment with respect to an all equity financed firm. This finding is explained by the fact that the increase in the probability of default, which is positively correlated with leverage, might induce a potential loss of the investment option and thus reduce the value of the option to wait providing equity holders with an incentive to speed up the investment. Second, if we introduce the financial constraint, the investment threshold is characterized by a U-shaped relation. The latter implies that the investment threshold diminishes as the financial constraint becomes less stringent, but up to a certain minimum value. After a certain amount of leverage the firm attitude towards R&D investment changes. The firm becomes more risk adverse, given the much higher probability of default (linked to a much higher leverage in its balance sheet).

Keywords

R&D Real options Capital budgeting Debt financing constraint 

JEL Classification

G1 G31 G32 D81 

Notes

References

  1. Aghion P, Bond S, Klemm A, Marinescu I (2004) Technology and financial structure: Are innovative firms different? J Eur Econ Assoc 2(2–3):277–288Google Scholar
  2. Aghion P, Bloom N, Blundell R, Griffith R, Howitt P (2005) Competition and Innovation: an Inverted-U Relationship. Q J Econ 120(2):701–728Google Scholar
  3. Bond S, Harhoff D, Reenen J (2006) Investment, R&D and financial constraints in Britain and Germany. Annales d'Economie et de Statistique (79–80):433–460Google Scholar
  4. Boyle GW, Guthrie GA (2003) Investment, uncertainty, and liquidity. J Financ 58(5):2143–2166Google Scholar
  5. Bragoli D, Cortelezzi F, Marseguerra G (2014) The Effect of Risky Debt on R&D Investment. Economia politica 31(2):149–172Google Scholar
  6. Bragoli D, Cortelezzi F, Marseguerra G (2016) R&D, capital structure and ownership concentration: evidence from Italian microdata. Ind Innovation 23(3):223–243Google Scholar
  7. Brown JR, Fazzari SM, Petersen BC (2009) Financing Innovation and Growth: Cash Flow, External Equity, and the 1990s R&D Boom. J Financ 64:151–185Google Scholar
  8. Brown J, Martinsson G, Petersen B (2012) Do financing constraints matter for R&D? Eur Econ Rev 56(8):1512–1529Google Scholar
  9. Cincera M, Ravet J (2010) Financing constraints and R&D investments of large corporations in Europe and the US. Sci Pub Policy 37(6):455–466Google Scholar
  10. Clementi GC, Hopenhayn HA (2006) A theory of financing constraints and firm dynamics. Quart J Econ 121(1):229–265Google Scholar
  11. Czarnitzki D, Kraft K (2009) Capital control, debt financing and innovative activity. J Econ Behav Organ 71(2):372–383Google Scholar
  12. Dasgupta P, Stiglitz J (1980) Uncertainty, industrial structure, and the speed of R&D. Bell J Econ 11:1–28Google Scholar
  13. Dixit A (1988) A General Model of R&D Competition and Policy. RAND J Econ 317–326Google Scholar
  14. Dixit A, Pindyck R (1994) Investment under uncertainty. Princeton, Princeton University PressGoogle Scholar
  15. ECB (2009) Survey on the Access to Finance of Small and Medium-sized Enterprises i n the Euro Area. European Central Bank, Frankfurt am MainGoogle Scholar
  16. Hajivassiliou V, Savignac F (2007) Financing Constraints and a Firm’s Decision and Ability to Innovate: Establishing Direct And Reverse Effects. FMG Discussion Papers No 594, Financial Markets Group, London School of Economics and Political ScienceGoogle Scholar
  17. Hall BH (2002) The financing of research and development. Oxf Rev Econ Policy 18(1):35–51Google Scholar
  18. Hall BH, Moncada PCP, Montresor S, Vezzani A (2016) Financing constraints, R&D investments and innovative performances: new empirical evidence at the firm level for Europe. Econ Innov N Technol 25(3):183–196Google Scholar
  19. Hart O, Moore J (1994) A theory of debt based on the inalienability of human capital. Q J Econ 109(4):841–879Google Scholar
  20. Himmelberg C, Petersen B (1994) R&D and internal finance: a panel study of small firms in high-tech industries. Rev Econ Stat 76:38–51Google Scholar
  21. Hottenrott H, Peters B (2012) Innovative capability and financing constraints for innovation: more money, more innovation? Rev Econ Stat 94(4):1126–1142Google Scholar
  22. Hu C, Jiang W, Lee C-F (2013) Managerial flexibility and the wealth effect of new product introductions. Rev Quant Financ Acc 41(2):273–294Google Scholar
  23. Jensen MC, Meckling WH (1976) Theory of the firm: managerial behavior, agency costs and ownership structure. J Financ Econ 3(4):305–360Google Scholar
  24. Jones DA (2018) Using real options theory to explain patterns in the valuation of research and development expenditures. Rev Quant Financ Acc 51:575Google Scholar
  25. Lambrecht B (2017) Real option in finance. J Bank Financ 81:166–171Google Scholar
  26. Lambrecht B, Perraudin W (2003) Real options and preemption under incomplete information. J Econ Dyn Control 27(4):619–643Google Scholar
  27. Lee T, Wilde LL (1980) Market structure and innovation: a reformulation. Q J Econ 94:429–436Google Scholar
  28. Leland H (1994) Corporate debt value, bond covenants, and optimal capital structure. J Financ 49:1213–1252Google Scholar
  29. Leland H (1998) Agency costs, risk management, and capital structure. J Financ 53(4):1213–1243Google Scholar
  30. Lyandres E, Zhdanov A (2010) Accelerated investment effect of risky debt. J Bank Financ 34(11):2587–2599Google Scholar
  31. Loury GC (1979) Market structure and innovation. Q J Econ 9(3):395–410Google Scholar
  32. Marseguerra G, Cortelezzi F (2009) Debt financing and real estate investment timing decisions. J Prop Res 26(3):193–212Google Scholar
  33. Marseguerra G, Cortelezzi F (2006) Investimenti irreversibili, interazione strategica e opzioni reali: analisi teorica ed applicazioni. Economia politica 23(2):265–302Google Scholar
  34. Mauer DC, Ott SH (2000) Agency costs, underinvestment, and optimal capital structure: the effect of growth options to expand. Project Flexibility, Agency, and Competition, Oxford University Press, OxfordGoogle Scholar
  35. Mauer DC, Sarkar S (2005) Real options, agency conflicts, and optimal capital structure. J Bank Financ 29(6):1405–1428Google Scholar
  36. McDonald R, Siegel D (1986) The value of waiting to invest. Q J Econ 101:707–728Google Scholar
  37. Mina A, Lahr H, Hughes A (2013) The demand and supply of external finance for innovative firms. Ind Corp Change 22(4):869–901Google Scholar
  38. Myers SC (1977) Determinants of corporate borrowing. J Financ Econ 5(2):147–175Google Scholar
  39. Modigliani F, Miller M (1958) The cost of capital, corporate finance, and the theory of investment. Am Econ Rev 48:261–297Google Scholar
  40. Mulkay B, Hall BH, Mairesse J (2000) Investment and R&D in France and in the United States. In: Herman H, Koning R (eds) Investing today for the world of tomorrow. Proceedings of the 2nd annual German Bundesbank spring policy conference. Deutsche Bundesbank. Springer, BerlinGoogle Scholar
  41. Musso P, Schiavo S (2008) The impact of financial constraints on firm survival andgrowth. J Evol Econ 18(2):135–149Google Scholar
  42. Nishihara M, Shibata T (2010) Interactions between preemptive competition and a financing constraint. J Econ Manag Strategy 19(4):1013–1042Google Scholar
  43. Sarkar S (2003) The effect of mean reversion on investment under uncertainty. J Econ Dyn Control 28:377–396Google Scholar
  44. Schwartz ES (2004) Patents and R&D as real options. Econ Notes 33:23–54Google Scholar
  45. Shibata T, Nishihara M (2012) Investment timing under debt issuance constraint. J Bank Finance 36(4):981–991Google Scholar
  46. Sundaresan S, Wang N (2006) Dynamic investment, capital structure, and debt overhang, working paper, Columbia Business SchoolGoogle Scholar
  47. Sundaresan S, Wang N (2007) Investment under uncertainty with strategic debt service. Am Econ Rev Papers Proc 97(2):256–261Google Scholar
  48. Trigeorgis L, Tsekrekos AE (2017) Real options in operations research: a review and synthesis. Eur J Oper Res 270:1–24Google Scholar
  49. Weeds H (2002) Strategic delay in a real options model of R&D competition. Rev Econ Stud 69(3):729–747Google Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  • Daniela Bragoli
    • 2
  • Flavia Cortelezzi
    • 1
    Email author
  • Pierpaolo Giannoccolo
    • 3
  • Giovanni Marseguerra
    • 2
  1. 1.Department of Law, Economics and CultureInsubria UniversityComoItaly
  2. 2.Department of Mathematics and EconometricsCatholic University of MilanMilanItaly
  3. 3.Department of EconomicsUniversity of BolognaBolognaItaly

Personalised recommendations