Innovation is perhaps the single most important driver of productivity and growth. However, firms do not innovate in isolation but rather within an ecosystem of their technological peers, as many classic studies show. More recent work finds that a given firm's innovation, productivity, and value increase as a result of technology spillovers from other firms.
Like knowledge spillovers generally, inventions have social value that can far exceed their private value to the inventor. Technological progress can create technologies not just for the inventor firm, but also for its peers. In a virtuous circle, the resulting technological progress of the peer firms can, in turn, create technologies for the inventor firm as well as for other peer firms, and on and on. In this manner, technology spillovers increase the productivity and value of assets of many firms that are related along technological lines.
A number of recent studies provide evidence that technology spillovers do affect corporate investment and the assets, both intangible and tangible, that they create. Technologies can spill over across firms intentionally, as when firms choose to merge, or unintentionally, as when knowledge is transferred through patents, research papers, conferences, social networks, and employees changing firms. Overall, there is a consensus that technologies spill over from one firm to another, stimulating investment and creating assets for technologically related firms.
We explore this subject in our paper, ‘Technology Spillovers, Asset Redeployability, and Corporate Financial Policies’. Taking as given the significant impact of technology spillovers on corporate investment, we study how firms choose the mix of debt and equity that they use to finance the investments resulting from technology spillovers. It is worth stressing that the investments to be financed need not involve R&D spending and may well create both intangible and tangible assets.
We hypothesize that technology spillovers to a firm increase the redeployability of its assets – that is, their usefulness in other contexts – and this ultimately leads the firm to increase its leverage. The starting point of our reasoning is that a key determinant of corporate leverage is the redeployability of the firm's assets. Indeed, for innovative firms in particular, low asset redeployability may be one of the most important reasons for which leverage is low. This is because innovative firms tend to have many firm-specific and few tangible assets (before considering technology spillovers), and potential lenders are therefore less willing to lend against the security of such assets.
The presence of technology spillovers across firms implies that the assets of a firm incorporate at least some of the technologies of its peer firms. For this reason, technology spillovers decrease the specificity of the firm's assets and increase their usefulness and value to the firm's technological peers. Such an increase in the redeployability of the firm's assets leads to lower losses to the firm's creditors in the event of bankruptcy. Therefore, the firm's debt capacity increases, its borrowing costs decrease, and the firm increases its leverage. It is these predictions that we test in our study.
We test our predictions using a sample of 694 innovative publicly traded firms during the years 1981-2001. Following a recent study by Bloom, Schankerman, and Van Reenen (2013), we capture potential technology spillovers to a firm by taking into account both the extent of its technological similarity with other firms and the stock of knowledge of other firms. Specifically, our measure of technology spillovers to a firm is calculated as the sum of the weighted R&D stocks of other firms, where the weights are based on the closeness of two firms in terms of their technologies. This technological proximity is measured as the distance between the technology activities of the two firms in the same technology space or similar technology spaces. Technology activities and spaces are captured by patents and patent classes, respectively.
From a statistical standpoint, we identify the effect of technology spillovers on financial policies using exogenous variation in federal and state R&D tax credits. In addition, we always account for product market spillovers to ensure that we separate the negative effect of the knowledge stock of product market competitors from the positive effect of the knowledge stock of technological peer firms. Finally, we include both firm fixed effects and industry-year fixed effects wherever possible.
Our results indicate that technology spillovers have a significant effect on financial policies. We find that leverage increases by 6 percentage points in response to a one-standard deviation increase in technology spillovers. This result comes from firms issuing more debt and less equity.
We then consider the asset redeployability channel through which technology spillovers can affect financial policies. To this end, we examine two direct consequences of technology spillovers increasing the productivity and value of the firm's assets in alternative use: greater collateralization of and market liquidity for the firm's asset. These are both consequences of greater asset redeployability because the more productive and valuable the firm's assets are to its technological peer firms, the more likely these assets are to be traded among firms and at a higher price. Lenders, in turn, should be more willing to accept these assets as collateral because, in the event of bankruptcy, they should be able to increase their recovery rate from selling the firm's assets. Therefore, we should observe more asset collateralization and greater asset liquidity as a result of technology spillovers.
Our results confirm both predictions. We find that technology spillovers significantly increase the firm's borrowing collateralized by all of its assets in general as well as a specific subset of its technology assets, namely, patents. We also find a significant increase in the sale of patents as well as entire firms, suggesting an increase in the liquidity of both specific and general technology assets.
Furthermore, greater asset redeployability also implies lower borrowing costs. We therefore also examine the effect of technology spillovers on bond and loan spreads. We find that for a one-standard deviation increase in technology spillovers, bond spreads decrease by roughly 6 basis points, and bank loan spreads decrease by 9 bps. Taken together, our findings suggest that technology spillovers increase the redeployability of the firm's assets and thereby lead to higher leverage.
Our study provides the first empirical evidence that technology spillovers have a significant impact on corporate financial policies. In so doing, it complements the young but growing literature on the effect of technology spillovers on corporate investment policies. Our study also improves understanding of financial decision-making, particularly in innovative firms. The prior literature establishes that the financing of technology assets presents unique challenges, whereas we go further and distinguish between assets created by technological peer firms rather than the firm itself. Finally, we contribute to the emerging literature on peer effects and corporate policies. A few prior studies focus on how a given firm's financial policies (eg, leverage) are influenced by its various types of non-technological peers firms, such as its customers and suppliers or product market competitors. Instead, we study firms that are technological peers to each other.
This post was first published here.
Phuong-Anh Nguyen and Ambrus Kecskés are both Associate Professors at York University - Schulich School of Business.