The (Self-)Funding of Intangibles

Abstract

We model how the evolution of investment towards intangible capital offers new implications for corporate funding, employee compensation and payout policy. Tangible capital can be purchased by firms and funded externally, while intangible capital is largely created by skilled workers investing their human capital and cannot be pledged. As a result, intangible capital requires lower upfront investment by firms, resulting in larger free cashflow, and more financial slack to avoid future funding constraints. On the other hand, firms need to promise more future cashflows to employees in the form of unvested equity grants, whose value is supported by retaining cash and favoring repurchases over dividends. The model thus predicts a human capital retention motive for financial prudence next to the traditional precautionary motive. Aggregate data appear consistent with these predictions, also for firms that do not appear financially constrained.

Keywords: Technological change, intangible assets, cash holdings, human capital, corporate leverage, equity grants, deferred equity, share vesting.

JEL Classification: G32, G35, J24, J33