Why Do Innovative Firms Hold So Much Cash? Evidence from Changes in State R&D Tax Credits

53 Pages Posted: 2 Oct 2014

See all articles by Antonio Falato

Antonio Falato

Board of Governors of the Federal Reserve System

Jae Sim

Board of Governors of the Federal Reserve System

Date Written: September 9, 2014

Abstract

This paper uses the staggered changes of R&D tax credits across U.S. states and over time as a quasi-natural experiment to examine the impact of innovation on corporate liquidity. By generating plausibly independent variation in firms' incentive to invest in R&D, we are able to assess the empirical importance of specific theories of the link between innovation and corporate liquidity. Firms increase (decrease) their cash to asset ratios by about one and a half percentage point when their home state increases (cuts) R&D tax credits. These baseline difference-in-differences estimates hold up to a battery of validation, falsification, and robustness checks, which corroborate their internal and external validity. The treatment effect of R&D tax credits increases monotonically with several specific proxies for debt and equity financing frictions. Increases (cuts) in tax credits also lead to increases (decreases) in the ratios of cash to bank lines of credit and to book equity, and to decreases (increases) in bank debt, secured debt, and overall net indebtness, supporting debt and equity financing channels through which innovation impacts the demand for cash. We also find support for a product market competition channel, and assess repatriation and agency explanations. Overall, our analysis offers endogeneity-free evidence that innovation is a first-order driver of corporate liquidity management decisions.

Keywords: Determinants of corporate cash holdings, financial economics of innovation

JEL Classification: G30, G32

Suggested Citation

Falato, Antonio and Sim, Jae W., Why Do Innovative Firms Hold So Much Cash? Evidence from Changes in State R&D Tax Credits (September 9, 2014). FEDS Working Paper No. 2014-72. Available at SSRN: https://ssrn.com/abstract=2503457 or http://dx.doi.org/10.2139/ssrn.2503457

Antonio Falato (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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