Cash Holdings and R&D Smoothing

38 Pages Posted: 11 Mar 2009 Last revised: 25 May 2011

See all articles by James R. Brown

James R. Brown

Iowa State University - Department of Finance

Bruce C. Petersen

Washington University in St. Louis - Department of Economics

Date Written: January 20, 2010

Abstract

The sharp increase in R&D investment in recent decades has important but unexplored implications for corporate liquidity management. Because R&D has high adjustment costs and is financed with volatile sources, it is very expensive for firms to adjust the flow of R&D in response to transitory finance shocks. The main contribution of this paper is to directly examine whether firms use cash reserves to smooth their R&D expenditures. We estimate dynamic R&D models and find that firms most likely to face financing frictions rely extensively on cash holdings to smooth R&D. In particular, our estimates suggest that young firms used cash holdings to dampen the volatility in R&D by approximately 75% during the 1998-2002 boom and bust in equity issues. Firms less likely to face financing frictions appear to smooth R&D without the use of costly cash holdings. Our findings provide new insights into the value of liquidity and the financing of intangible investment, and suggest that R&D smoothing with cash reserves is now important for understanding cash management for a substantial fraction of publicly traded firms.

Keywords: Cash holdings, R&D, Value of liquidity, Investment smoothing

JEL Classification: G31, G32

Suggested Citation

Brown, James R. and Petersen, Bruce Clayton, Cash Holdings and R&D Smoothing (January 20, 2010). Journal of Corporate Finance, Vol. 17, No. 3, pp.694-709, 2011. Available at SSRN: https://ssrn.com/abstract=1356271

James R. Brown (Contact Author)

Iowa State University - Department of Finance ( email )

Ivy College of Business
Ames, IA 50011
United States
5152944668 (Phone)

Bruce Clayton Petersen

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States
314-935-5643 (Phone)

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