Knowledge Cycles and Corporate Investment
63 Pages Posted: 11 Jul 2019
Date Written: July 11, 2019
We propose a theory of how the process of knowledge creation within firms affects their investment decisions. Firms accumulate knowledge through successive rounds of experimentation in the form of capital expenditures, and reset knowledge when they explore new technologies. This process generates endogenous knowledge cycles, which govern firms' investment. Because risky experimentation makes firms information averse, investment increases in knowledge but Q decreases in knowledge. The relationship between investment and Q thus varies over the knowledge cycle and is strongest early in the cycle. We find empirical support for the knowledge channel using a text-based measure of knowledge cycles from public firms. The knowledge channel could explain why investment has been weak in recent years despite high valuation.
Keywords: Experimentation, Exploration, Investment, Knowledge, Information Aversion, Intangibles.
JEL Classification: G31,D83
Suggested Citation: Suggested Citation