innovation and leverage

John F. Burr Jr., Purdue University West Lafayette

Document Type Article

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Abstract

This research proposal is motivated by literature that suggests firms wishing to be innovators need lower leverage. In this work, we seek to address the question, “when can innovation and debt co-exist?” Empirical evidence shows a reduction of R&D intensity as leverage increases, implying that firms wishing to make investments in research and development will do so at the expense of the benefits of debt. Unfortunately, nearly all previous work has failed to articulate a mechanism by which innovation proceeds in the presence of debt. It is also assumed in the agency literature that reduction of free cash flow will increase the average quality of investment as lower value adding projects are culled out of the mix. Nearly all previous work has failed to investigate a key assumption in the agency literature—whether the reduction in slack, through the manipulation of debt, is an appropriate governance mechanism for the outcomes associated with investments in R&D.