Reconciling the Firm Size and Innovation Puzzle

31 Pages Posted: 3 Apr 2016 Last revised: 7 Mar 2019

See all articles by Anne Marie Knott

Anne Marie Knott

Washington University in St. Louis - John M. Olin Business School

Carl Vieregger

Drake University, College of Business and Public Administration

Date Written: November 11, 2018

Abstract

There is a prevailing view in both the academic literature and the popular press that firms need to behave more entrepreneurially. This view is reinforced by a stylized fact in the innovation literature that R&D productivity decreases with size. A second stylized fact in the innovation literature is that R&D investment increases with size. Taken together, these stylized facts create a puzzle of seemingly irrational behavior by large firms—they are increasing spending despite decreasing returns. This paper is an effort to resolve that puzzle. We propose and test two alternative resolutions: 1) that the puzzle arises from mismeasurement of R&D productivity; and 2) that firm size endogenously drives R&D strategy, and that the returns to R&D strategies depend on scale. We were unable to resolve the puzzle with the second tack: while firm size affects R&D strategy in the manners expected by theory, there was no strategy whose returns decreased in scale. We were however able to reconcile the puzzle under the first tack. Using a fairly recent measure which matches the returns to R&D construct in the firm size theories, we found that both R&D spending and R&D productivity increase with size. Taken together, these results offer a reconciliation of the firm size innovation puzzle—large firms are indeed acting rationally in their increasing R&D investments, as one would expect.

Suggested Citation

Knott, Anne Marie and Vieregger, Carl, Reconciling the Firm Size and Innovation Puzzle (November 11, 2018). US Census Bureau Center for Economic Studies Paper No. CES-WP- 16-20. Available at SSRN: https://ssrn.com/abstract=2756232 or http://dx.doi.org/10.2139/ssrn.2756232

Anne Marie Knott (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

Carl Vieregger

Drake University, College of Business and Public Administration ( email )

2507 University Avenue
Des Moines, IA 50311
United States

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