On the Relations between R&D Investments and Financing Constraints in South Korea

R&D investments might be more important than are capital investments to economics growth. However, they are vulnerable to cutback due to financing constraints more than are capital investments because their collateral value is minimal and asymmetric information is severe. While the literature covers the effect of financing constraints on R&D investments for firms in the U.S., European countries, and India, it lacks studies in Korean firms. This article examines the relations between R&D investments and financing constraints for South Korean firms. Our sample includes financial data and stock prices of industrial firms listed on KOSPI market of Korea Exchange (KRX) during the period 2001~2014, is screened with typical criteria, and is annually constructed. To identify whether financing constraints are binding R&D investments, we focus on controlling for two factors in addition to cash flow. One factor is external financing such as equity and debt issues and the other factor is R&D smoothing through cash holdings and trade credit. The adopted methodology in our dynamic panel analysis is ‘system GMM (generalized method of moments)’, which provides general estimators constructed for cases with: ‘small T, large N’ panel data, implying few time periods and many subjects; independent variables that are allowed to be endogenous, meaning that they are correlated with past and possibly current realizations of the error; fixed effects; and heteroskedasticity and autocorrelation within subjects. We present our findings in three categories. First, we find evidence that R&D investments are positively related to cash flow, implying that R&D investments is sensitive to the availability of cash flow, which financially constrains corporate R&D activities due to imperfect capital markets and unique characteristics of R&D investments. Second, cash holdings and trade credit are found to have insignificant impacts on R&D investments, suggesting that Korean firms are not engaged in R&D smoothing through cash holdings and/or trade credit when they temporarily experience cash shortage. Finally, for external financing we show that R&D investments are affected by debt financing, but not by equity financing in Korean firms. In the absence of equity issues for R&D activities, policymakers might want to consider stock market to take active roles in funding R&D activities when R&D investment demand outstrips internal financing.