Accelerability vs. scalability : R&D investment under financial constraints and competition

I develop a continuous-time model to examine how the interaction between competition and financial constraints affects firms’ research and development (R&D) strategies. The model integrates two key characteristics of R&D investment: accelerability (i.e., higher R&D intensity leads to faster discovery) and scalability (i.e., higher R&D intensity leads to higher project payoff). I find that firms react strategically to their rivals’ financial constraints when making investment decisions in a duopoly R&D race. In particular, firms respond positively to the R&D intensity of an unconstrained rival, while they respond in a hump-shaped fashion to the R&D intensity of a constrained rival. As a result, a constrained firm can pre-empt an unconstrained competitor in market equilibrium. Accelerability is necessary for such pre-emption to occur, and scalability generally reduces its likelihood. Comparison with a monopoly benchmark shows that the economic mechanism differs from over-investment induced by financial constraints alone. The model also generates new implications regarding how project characteristics and cash flow risks impact R&D decisions

Dividend and capital gains taxation under incomplete markets

Motivated by the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003, the effects of capital income tax cuts are investigated in an economy with heterogeneous households and a representative, mature firm. Dividend tax cuts, contrary to capital gains tax cuts, lead to a decrease in investment and capital. This is because they increase the market value of existing capital and households require a higher return to hold this additional wealth. In line with empirical evidence, the model predicts substantial increases in dividends and stock prices. Overall, the tax cuts lead to a welfare reduction equivalent to a consumption drop of 0.5%

Essays on Financial Constraints, R&D Investments, and Competition

This dissertation consists of two chapters of theoretical studies that investigate the effect of financial constraints and market competition on research and development (R&D) investments. In the first chapter, I explore the impact of financial constraints on two different types of R&D investments. In the second chapter, I examine the impact of market competition on the relationship between financial constraints and R&D investments. In the first chapter, I develop a dynamic monopoly model to study a firm’s R&D strategy. Contrary to intuition, I show that a financially constrained firm may invest more aggressively in R&D projects than an unconstrained firm. Financial constraints introduce a risk that a firm may run out of money before its project bears fruit, which leads to involuntary termination on an otherwise positive-NPV project. For a company that relies on cash flow from assets in place to keep its R&D project alive, early success can be relatively important. I find that when the discovery process can be expedited by heavier investment (“accelerable” projects), a financially constrained company may find it optimal to “over”-invest in order to raise the probability of project survival. The over-investment will not happen if the project is only “scalable” (investment scales up payoffs). The model generates several testable implications regarding over-investment and project values. In the second chapter, I study the effects of competition on R&D investments in a duopoly framework. Using a homogeneous duopoly model where two unconstrained firms compete head to head in an R&D race, I find that competition has no effect on R&D investment if the project is not accelerable, and the competing firms are not constrained. In a heterogeneous duopoly model where a financially constrained firm competes against an unconstrained firm, I discover interesting strategic interactions that lead to preemption by the constrained firm in equilibrium. The unconstrained competitor responds to its constrained rival’s investment in an inverted-U shape fashion. When the constrained competitor has high cash flow risk, it accelerates the innovation in equilibrium, while the unconstrained firm invests less aggressively and waits for its rival to quit the race due to shortage of funds

Dividend and capital gains taxation under incomplete markets

Abstract Motivated by the Jobs and Growth Tax Relief Reconciliation Act of 2003, we study the effects of capital income tax cuts in a framework where firms make investment decisions to maximize their market value and households are subject to uninsurable labor income risk. We find that the effects of capital gains tax cuts are qualitatively similar to those found in the absence of household heterogeneity. However, dividend tax cuts surprisingly lead to a reduction in aggregate investment. This is because they increase the market value of the existing capital. In equilibrium, households then require a higher return to hold this additional wealth, leading to a lower capital stock. This also implies that dividend tax cuts are welfare reducing in the long run, not only because of the traditional reasons of redistribution from poor to rich, but also because of a fall in aggregate output and consumption. Taking into account the transition mitigates the losses but the JGTRRA tax cuts still lead to a welfare reduction equivalent to a 0.5% drop in consumption. In line with empirical evidence, the model also predicts substantial increases in dividends and stock prices following the tax cuts

The effect of board independence on firm performance- new evidence from product market conditions

We study the effect of corporate board independence on firm performance under different product market conditions. Using customer–supplier links to identify exogenous downstream demand shocks, we find that firm performance is positively associated with board independence when the firm-specific product demand drops. The results are stronger for smaller firms and firms with high growth and more volatile stock returns. The findings prevail if the firm faces a medium level of product market competition or a medium level of downstream demand shock. We provide suggestive evidence for the board's monitoring function driving the effectiveness of board independence in bad times of idiosyncratic risks, rather than its advisory function