Review of Industrial Organization 22: 159–174, 2003.
© 2003 Kluwer Academic Publishers. Printed in the Netherlands.
Is R&D Financially Constrained? Theory and
Evidence from Irish Manufacturing
SPIROS BOUGHEAS and HOLGER GÖRG
School of Economics, University of Nottingham, Nottingham NG7 2RD, U.K.
CORE, Universite Catholique de Louvain
Abstract. We re-examine the effects of liquidity constraints on R&D investment. In our theoretical
section we extend the neoclassical framework of investment in physical capital by introducing R&D
and liquidity constraints. We analyse this issue empirically using ﬁrm-level data for R&D active
manufacturing ﬁrms in the Republic of Ireland. Our results provide evidence that suggests that R&D
investment is ﬁnancially constrained. This is in line with previous studies of U.S. ﬁrms.
Key words: Financial constraints, R&D.
JEL Classiﬁcation: O32.
It is widely accepted that internal ﬁnance is the most important funding source
for investment in Research and Development (R&D). Although there have been
a number of empirical studies addressing this issue, they have not been based on
explicit models of R&D ﬁnancing but have relied on theoretical arguments bor-
rowed from the ﬁnance literature. These include papers by Leland and Pyle (1977)
and Myers and Majluf (1984) which suggest that R&D projects, which face long
and uncertain payoffs, are subject to high lemon’s premia because of the inability
of outside investors to distinguish their quality. External ﬁnance opportunities for
inventive activities are also restricted by moral hazard arising from risk assessment
problems, as suggested by Arrow (1962). Furthermore, R&D projects lack tangible
assets that can be used as collateral which, as demonstrated by Bester (1985), can
mitigate incentive problems. All of the above arguments offer potential explana-
tions for the reluctance of outside investors to ﬁnance R&D. There is an additional
argument, suggested by Bhattacharya and Ritter (1985), that stresses the reluctance
of ﬁrms to ﬁnance their R&D externally because of the cost of revealing the quality
of their innovation to the market.
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