Law, the Nature of Financial Intermediation and Investment
(English)Article in journal (Other academic) Submitted
We study how law and the nature of financial market development impact firm-level investment spending. We argue that legal rules that protect shareholders and therefore increase the availability of external equity finance can have important real effects through a “financing R&D channel”. R&D investment is dependent on the supply of external equity because debt contracts are often unsuitable for financing intangible investment. Usingexogenous variation in access to external equity arising from differences in legal rules across countries, we find a very strong link between external equity finance and investment in R&D at the firm-level. We estimate that firms dependent on external finance at the margin increase long-run R&D investment by $0.50 to $0.60 for each dollar increase in long-run access to external equity. In contrast, access to external equity has little impact on long-run physical investment levels. These findings show that R&D investment is especially sensitive to the particular form of financial intermediation, likely because firms can more readily use debt to contract around weak investor protections when it comes to financing fixed investment. Given the importance of R&D investment for innovation and productivity growth, our study highlights a direct causal channel that can connect legal rules and financial development with firm activities key to economic growth.
Economics and Business
IdentifiersURN: urn:nbn:se:kth:diva-25246OAI: oai:DiVA.org:kth-25246DiVA: diva2:356740
QC 201010132010-10-132010-10-132010-10-13Bibliographically approved