Sources of Finance for R&D Investment: Empirical Evidence from Portuguese SMEs Using Dynamic Estimators

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ABSTRACT

This paper makes two specific contributions to the SME literature: (i) it is pioneering in using the two-step estimation method, considering SME R&D intensity as dependent variable and cash flow, short and long-term debt and government subsidies as determinants; and (ii) the empirical evidence obtained allows us make important empirical contributions. Cash flow and short-term debt, regardless of the respective level, influence positively R&D intensity by SMEs. Secondly, long-term debt and government subsidies are only important for increased R&D intensity for higher levels of long-term debt and government subsidies. The multiple empirical evidence obtained in this study allows us to make important suggestions to policy-makers, as well as to SME managers/owners.

Keywords: dynamic estimators; entrepreneurial finance; external finance; internal finance; R&D Investment; SMEs

INTRODUCTION

Innovative activities take on special relevance as a catalyzing factor of countries' economic growth, contributing to sustainable processes of economic convergence (Peters 2004). Regarding the expected benefits of an entrepreneurial society based on knowledge and business innovation, we may point out (Audretsch 2007; Müller & Zimmermann 2009): (i) firms that concentrate on innovation activities can grow at higher rates than those with less innovative propensity, given that the former have access to specific resources and skills that allow them to better explore new markets and investment opportunities, and in this way increasing the producers' surplus; and (ii) consumers benefit from a more diversified range of goods and services.

In the majority of countries, although large firms have generally greater capacity for investment in Research and Development (R&D), SMEs1 are the principal agents of technological change, innovation and economic growth. Therefore, SMEs' R&D activities can be fundamental for economic growth, productivity and qualified employment, generating added value (Müller & Zimmermann 2009).

Access to sources of finance for R&D activities is very important, given that it directly influences implementation of SMEs' R&D activities in two ways: (i) the selected source of finance mitigates liquidity constraints, which are frequently an obstacle to SME innovation; and (ii) the selected source of finance influences the outcome of innovation, given that it promotes or discourages acceptance of the risk associated with R&D activities (Smith 2010).

Small and medium enterprisess with high levels of investment in R&D activities may have problems in obtaining external finance due to problems of asymmetric information. As a result, their insufficient internal finance may have negative consequences for R&D activities, which are associated with greater investment in intangible assets, and higher technical and market uncertainty (Smith 2010). These aspects together generate asymmetric information problems, and consequently lenders2, namely banks and suppliers, impose severe conditions when granting credit to SMEs. Furthermore, the majority of SMEs do not fill the requirements to achieve quotation in the stock market, and the SMEs' owners are adverse to external equity, avoiding the loss of firm's control and independence. Considering the restrictions faced by SMEs in obtaining finance from external sources, we can expect innovative SMEs to be extremely dependent on internal finance to fund R&D activities. However, when internal finance is insufficient, SMEs may be forced to finance R&D activities with debt. Intangible assets, which do not serve as collateral, as well the market and technical uncertainty associated with R&D activities, may imply severe conditions in accessing debt. In this context, for lenders it is easier to monitor commitments associated with short-term debt than long-term debt (Myers, 1977). The need to pay off the debt and its charges over a very short period oblige firm's managers/owners to be more disciplined financially, reducing the possibility for less than optimal investment. …