The Bright Side of Cash Holdings: Innovation Efficiency

Abstract

We find that firms with higher cash-to-assets ratios obtain more patents and patent citations for a given amount of research and development expenditures. We propose that large cash reserves increase managerial incentives to innovate by reducing the risk to their career from undertaking innovative projects. To establish causality, we employ two quasi-natural experiments to identify exogenous stimulation of innovation. Difference-in-differences estimations support the causal impact of cash holdings on innovation efficiency. Further analysis reveals that the effect of cash holdings on innovation is stronger for firms with tighter financial constraints, lower institutional ownership, or poorer managerial compensation incentives.

Keywords: Cash holdings; Innovation; Tolerance for failure; Patents; Patent citations

JEL Classification: O31, G32