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Cash holdings and R&D smoothing

  • Brown, James R.
  • Petersen, Bruce C.

The sharp increase in R&D investment in recent decades has important but unexplored implications for corporate liquidity management. Because R&D has high adjustment costs and is financed with volatile sources, it is very expensive for firms to adjust the flow of R&D in response to transitory finance shocks. The main contribution of this paper is to directly examine whether firms use cash reserves to smooth their R&D expenditures. We estimate dynamic R&D models and find that firms most likely to face financing frictions rely extensively on cash holdings to smooth R&D. In particular, our estimates suggest that young firms used cash holdings to dampen the volatility in R&D by approximately 75% during the 1998-2002 boom and bust in equity issues. Firms less likely to face financing frictions appear to smooth R&D without the use of costly cash holdings. Our findings provide new insights into the value of liquidity and the financing of intangible investment, and suggest that R&D smoothing with cash reserves is now important for understanding cash management for a substantial fraction of publicly traded firms.

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Article provided by Elsevier in its journal Journal of Corporate Finance.

Volume (Year): 17 (2011)
Issue (Month): 3 (June)
Pages: 694-709

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Handle: RePEc:eee:corfin:v:17:y:2011:i:3:p:694-709
Contact details of provider: Web page: http://www.elsevier.com/locate/jcorpfin

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