Cash-constrained R&D Investment

Herbert Dawid, Frank Riedel, Jan-Henrik Steg and Xingang Wen
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Herbert Dawid: Center for Mathematical Economics, Bielefeld University
Frank Riedel: Center for Mathematical Economics, Bielefeld University
Jan-Henrik Steg: Center for Mathematical Economics, Bielefeld University
Xingang Wen: Center for Mathematical Economics, Bielefeld University

No 699, Center for Mathematical Economics Working Papers from Center for Mathematical Economics, Bielefeld University

Abstract: We study endogenous, credit-financed innovation under uncertainty in dynamic con- texts. In our model, a firm with limited cash reserves decides how much to invest in an R&D project, potentially using external financing. Investing more increases the proba- bility of a sooner innovation, but higher repayment obligations also increase bankruptcy risk if the innovation takes longer. We show that the firm reduces its investment dis- continuously if the financing cost is not favorable enough, in order to avoid the need for external financing. This insight implies that policies reducing financing costs can have discontinuous positive effects on investment, innovation rate and welfare. How- ever, policy measures increasing the effectiveness of R&D might reduce the innovation rate and welfare due to a discontinuous reduction of R&D investment. Furthermore, we find that low financing costs can lead to over-investment. The welfare loss from cash constraints is more severe for radical innovations compared to incremental ones.

Keywords: Innovation; R&D investment; Cash constraints; Bankruptcy risk (search for similar items in EconPapers)
Pages: 26
Date: 2024-12-09
New Economics Papers: this item is included in nep-cfn, nep-ent, nep-ind, nep-ino, nep-ppm, nep-sbm and nep-tid
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