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Does R&D intensity influence leverage? Evidence from Indian firm-level data

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Abstract

The paper examines the association between corporate leverage and their investment in R&D. Towards this end, it develops certain testable propositions. These propositions are tested using a dataset of manufacturing firms in India covering the period 1995–2010. Three main results are gleaned from the analysis. First, the optimal leverage ratio typically declines with R&D intensity. Second, the financial crisis has exerted a negative effect on leverage for firms. And finally, the dampening effect of R&D intensity on leverage is the highest for foreign private firms.

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Notes

  1. The small- and medium-sized firms, as classified by the Indian Ministry of Micro, Small and Medium Enterprises, are those with investment in plant and machinery up to INR 100 million (approximately US $2.5 million).

  2. The National Stock Exchange, the state-of-the-art exchange for listed companies, became operational from end 1994, which is why we focus on data from 1995 onwards.

  3. R&D expenses often accounts for less than 1 % of turnover. Accordingly, companies often do not separately report such expenditures. This lack of a mandatory disclosure of R&D expenditures in accounts could be a source of bias because it is not evident whether the firm does not incur any expense on R&D or, alternately, whether it does but chooses not to report. Owing to this fact, even if a company reports zero R&D expenses, we retain it in the sample.

  4. We also checked the impact of the financial crisis on leverage. The univariate tests indicate that the leverage, which was 0.340 in non-crisis years (SD = 0.191), declined to 0.327 (SD = 0.209) in the crisis years, and the differences were statistically significant.

  5. The deep pocket policy suggests that the firm accumulates a significant quantum of funds in an earlier period to develop the project.

  6. The rationale for using short-term leverage (in addition to leverage) rests on the fact that in a bank-dominated financial system as in India, it is typically big banks who lend debt and they may be concerned about recovery of their funds in the event of a bankruptcy of the firm. So while overall debt (comprising of bank plus non-bank debt) might be increasing owing to increasing recourse by corporates to non-bank debt (such as borrowings from development banks, debentures etc.), short-term debt (which is primarily bank debt) could be declining, since banks may discourage managers from investing in sunk costs. Therefore, a positive relationship between short-term leverage and R&D activity could signify risk aversion on the part of banks.

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Acknowledgments

I would like to thank three anonymous referees and especially the Editor for their useful insights on an earlier draft which greatly improved the exposition and analysis. Needless to state, the views expressed and the approach pursued in the paper reflects the personal opinion of the author.

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  1. Department of Economic Analysis and Policy, Reserve Bank of India, New Central Office Building, S B S Marg, Fort, Mumbai, Maharashtra, 400001, India

    Saibal Ghosh

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Ghosh, S. Does R&D intensity influence leverage? Evidence from Indian firm-level data. J Int Entrep 10, 158–175 (2012). https://doi.org/10.1007/s10843-012-0087-4

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