The impact of country-level corporate governance on research and development

We investigate the process through which country-level corporate governance facilitates firm-level investment in research and development (R&D). Taking cash flow as one of the main determinants of R&D, we derive an econometric model that introduces a number of corporate governance factors (legal protection, financial system, and control mechanisms) to analyze their impact on R&D-cash flow sensitivity. Using data from nine European Union countries, Japan, and the United States, we show that R&D at the firm level is less sensitive to internal cash flow in countries with effective investor protection, developed financial systems, and strong corporate control mechanisms. Specifically, our analysis suggests that the characteristics of the corporate governance system that facilitate R&D are a common law legal environment, minority shareholder protection, strong law enforcement, a bank-based financial system, effective board control, and a strong market for corporate control. This evidence points to corporate governance as a key element in R&D investment, and contributes to the debate on whether country-level corporate governance systems can facilitate R&D projects and, indirectly, promote economic growth.