Government Spending, Aggregate Demand Sensitivity, and Corporate Innovation
44 Pages Posted: 8 Dec 2017 Last revised: 5 May 2020
Date Written: May 5, 2020
We show that the extent to which government spending hinders innovation is highly dependent on a firm’s revenue sensitivity to consumer demand. Demand sensitivity effects are stronger for firms that are more dependent on internal financing to fund innovative activity such as firms with high intangible assets and low cashflows. Managers respond to declines in earnings by reducing investments and increasing cash holdings. Payouts and external financing remain unaffected, suggesting that managers view changes in government spending as transitory shocks. Finally, the demand sensitivity channel operates independently of the resource diversification and crowding out mechanisms documented in prior studies.
Keywords: Government spending, innovation, patents, R&D expenditure, new product announcements, crowding-out effect
JEL Classification: G31, G38, H32
Suggested Citation: Suggested Citation