Is there a case for an augmented Tobin’s Q model of R&D investment? Investigating the role of market structure, knowledge spillovers and corporate governance quality
The determinants of R&D investment at firm-level have been a topic of interest for economists for a long time. However, our knowledge of the firm’s R&D investment behaviour remains somewhat fragmented. In this thesis, I postulate the idea of an augmented Tobin’s Q model, in which several different but not mutually exclusive theories can be considered together in explaining the R&D investment decision-making process at firm-level. The first contribution of this thesis is to bring back to the literature on firm investment in general and R&D investment in particular the Tobin’s Q theory, or more precisely, the role of market returns adjusted for replacement cost of capital and its implications for expectations formation. To do this, I propose using the one-period-ahead growth rate of Tobin’s average Q instead of average Q itself as a measure of expected profitability and investment opportunities. Second, I argue that this measure can only reflect one part the information set that managers take into account in forming their investment decisions. Hence, the model is augmented and tested empirically with three other factors: product-market competition, the level of R&D spillovers and corporate governance quality, all of which I demonstrate to have a significantly effect on desired R&D investment at firm-level in the literature. Taking the system generalised method of moments estimator to a rich data set of 3,718 manufacturing firms from 15 OECD countries over the 2005-2013 period, the thesis reports several findings. First, the one-period-ahead growth rate of Tobin’s average Q, which corresponds to one-period-ahead market rate of return weighted with one-period-ahead change in replacement cost of capital, has a positive and significant effect on firm R&D investment. However, it cannot explain the rate of R&D investment fully – in contrast to the neoclassical theory that predicts the investment opportunity reflected by Tobin’s marginal Q can be the sole determinant of R&D or physical capital investment. In my results, while the positive effect of the one-period-ahead growth rate of Tobin’s average Q remains a significant determinant of R&D investment, I also find: (i) an inverted-U shape relationship between product-market competition and R&D investment; (ii) significant effects of both intra- and inter-industry spillovers that indicate both knowledge externalities and ‘market-stealing’ effects, depending on the level at which the spillover pools are constructed; and (iii) some mixed effects of governance quality on R&D investment. The last contribution of this research relates to observed source of heterogeneity in the relationship between the one-period-ahead growth rate of Tobin’s average Q and R&D investment. I find that the effect of the one-period-ahead growth rate of Tobin’s average Q is stronger when the firms are either small or medium-sized, but it is weaker and insignificant when the firm’s R&D intensity level is lower than the average R&D intensity in its two-digit SIC industry over the 2005-2013 period of investigation.
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