Free Cash Flow and R&D Productivity
45 Pages Posted: 14 Feb 2015 Last revised: 29 Jun 2016
Date Written: June 29, 2016
This paper finds that free cash flow reduces the efficiency with which firms’ convert R&D investment into innovative output. This negative relation is robust to numerous controls, firm fixed effects, and endogeneity concerns. The negative association observed for the average firm is not driven by managerial empire building incentives, but rather by the misalignment of incentives between research employees and corporate shareholders. Further analysis reveals that the relation is sensitive to financing frictions, with free cash flow induced R&D investment being less productive and being valued more negatively primarily amongst financially unconstrained firms. These results highlight that agency conflicts between employees and shareholders are prevalent in the innovation process, with these conflicts being exacerbated by the availability of internal resources.
Keywords: Innovative efficiency; Free cash flow; Agency conflicts
JEL Classification: G32, G34, G39
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