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Nabokin, Tatjana (2014): Financing and internationalization of R&D intensive firms. Dissertation, LMU München: Faculty of Economics



Knowledge and knowledge-based value creation processes play an increasing role in modern economies. In the last two decades investments in knowledge have gained importance relative to investments in physical assets. The OECD reports that private and public investments in knowledge as percentage of GDP have increased by 0.7 percentage points in OECD countries during the years 1997-2004. At the same time, investments in physical assets such as machinery and equipment have decreased by 1.1 percentage points. The increasing importance of intangible assets in the value creation process presents a significant challenge for innovation policies in knowledge-based economies. Innovative firms that intensely invest in research and development (R&D) highly rely on intangible assets and are faced with serious market failures. These frictions can restrict R&D intensive firms' innovation and internationalization activities and are expected to hamper overall technological progress and economic growth. Imperfect financial markets that are characterized by information asymmetries can restrict the access to finance for R&D intensive start-up firms. These firms have only short track records and due to their focus on R&D, they have only few tangible assets that can be used as collateral for financial investors. Thus, financial frictions are particularly severe for new firms and firms undertaking innovative activities (Hall and Lerner, 2009). At the same time, young and small firms significantly contribute to technological progress and economic growth (OECD, 2013). Financial constraints restrain the innovation activities of these firms and result in an overall decelerated rate of innovation and a slowdown in economic progress. Further, R&D intensive firms additionally face the problem that their created knowledge exhibits the characteristics of public goods. Once information on inventions is revealed, the knowledge is non-rival and non-excludable. A sufficient patent protection is necessary to maintain investment incentives and to overcome problems of underinvestment. In their internationalization strategy, R&D intensive firms have to consider that patent law is a territorial concept, i.e., the scope of patent protection is limited to the territory of the country where the right is granted. The foundation of a foreign affiliate represents a transaction, whereby sensitive knowledge is transferred outside the firm and intangible assets are exposed to a high risk of infringement. A lacking or insufficient patent protection in host countries can distort global investment decisions and prevent profitable projects. Particularly R&D intensive multinational firms that intensely rely on intangible assets are expected to be highly affected by these frictions. Distorted investments could adversely affect a firm's growth and restrict the technological progress in host countries. This dissertation attempts to shed more light onto these market imperfections, which are aggravated by firms' reliance on intangible assets and are expected to adversely affect firms' innovation and internationalization strategy. The first two chapters deal with frictions in financial markets. Chapter 1 takes a step back and investigates how access to finance can be precisely measured. A precise measurement is essential to design effective policy measures in order to foster access to finance. On the basis of these findings, Chapter 2 considers the access to external finance of R&D intensive start-up firms and empirically investigates whether patents can mitigate financial frictions of these innovative firms. The third chapter considers frictions in the internationalization strategies of R&D intensive firms. It empirically investigates, whether a strengthening of national patent law affects the global investment decision of multinationals and encourages foreign direct investment. The first chapter is concerned with the empirical methodology of measuring access to finance. Measuring and identifying financial constraints represents an important challenge in empirical studies. Due to data limitations, access to finance has often been approximated by the usage of finance or by perception-based indicators. However, these types of measures disregard firm-specific differences in the demand for external finance. Firms that do not use external finance can either be financially constrained or might have no demand for external finance. Similarly, firms reporting that they do not face problems with access to finance may either have sufficient access or may have no financial demand. Using unique firm-level survey data which provides information on a firm's demand for credit, we develop a direct measure of access to credit. This measure takes into account whether a firm that has credit demand is successful in obtaining access to credit. In the first part of the analysis, we use our direct measure to estimate the determinants of access to credit. Thereby, we can separate the determinants affecting credit demand from those affecting access. In the second part, we estimate the determinants affecting the usage of credit and the perceived access respectively. A comparison of the identified determinants with those from the access estimation reveals whether the approximating measures allow for a precise identification of credit constraints. We find that the usage of credit is not adequate to identify financially constrained firms, since the determinants of demand and the determinants of access are not disentangled in the usage measure. Perception based indicators, however, are found to be surprisingly precise, even when information on demand is not available. Based on these findings, recommendations for future survey design for investigating access to finance are drawn. Our results imply that including questions on the demand for external finance is essential to identify access to finance. Further, since firms can be discouraged from applying, information on the application for finance is not sufficient and reasons for why firms have not applied for external finance should be additionally considered. We contribute to the literature by evaluating whether the usage of credit is a suitable approximation for access to credit and whether perception-based indicators provide precise measurements of credit constraints. To the best of our knowledge, this is the first empirical evaluation of these measures. A precise measure of access to finance is essential for drawing correct policy recommendations from economic research and to design efficient policy measures with the aim of fostering access to finance. The second chapter turns to the financing of R&D intensive start-up firms. It investigates the role of patents in their external finance and examines whether patents can improve the access to external financing for innovative start-up firms. Patents have the potential to reduce information asymmetries between patentees and investors (Long, 2002) and can also be seen as a type of property rights, since patents are fully transferable as well as exclusive and binding against third parties (Davies, 2006). Using detailed firm-level survey data of German start-up firms, we identify a firm's financial demand for venture capital and bank financing and investigate whether a firm that has demand for a particular source of finance is successful in obtaining it. To measure a firm's patenting activity and to distinguish high valuable patents, we use value-weighted patent counts that are based on the direct valuations by the patent owners. Instrumental-variable estimations take into account the potential endogeneity of patenting and establish a causal effect of patents. The analysis reveals two important findings. First, we find strong evidence for its endogeneity and provide a possible instrumentation strategy for patenting. Ignoring the endogeneity of patenting can result in highly biased estimates. Second, our results indicate that patenting significantly increases the probability of using venture capital and bank financing, especially when the values of patents are considered. However, it is not clear whether an increase in the usage of external finance can be fully attributed to an improved access to finance or whether part of the increase is due to an increased financial demand of patenting firms. Using separate measures for demand and access, we can clearly identify a demand driven effect of patents. Patenting firms have a significantly higher demand for external finance, while, after controlling for financial demand, no effect on access to external finance has been found. The contribution of the second chapter is primarily methodical. For future research on the financial role of patents, our findings emphasize the importance of considering endogeneity issues of patenting and controlling for firm-specific differences in financial demand. We can show that a large part of the increase in the usage of external finance can be attributed to a significantly higher financial demand of patenting firms. This leads to the question, whether the findings in the previous literature on the usage of external finance can be fully attributed to a signaling effect of patents or whether the identified effect is driven by a higher financial demand of patenting firms. Further, most previous studies on the role of patents in financing have not considered issues of endogeneity. Taking into account our results, it is not clear whether previous findings can be interpreted as causal effects or mere correlations. The third chapter deals with frictions due to a lack of patent protection and empirically investigates the role of patent protection in the global investment decisions of German multinationals. Using a firm-level panel dataset on the universe of German outward foreign direct investment (FDI), we investigate individual firm-level investment decisions at the extensive and intensive margin of FDI. At the extensive margin, we explore the impact of patent protection on the decision where to locate a foreign affiliate. At the intensive margin, we analyze how the strengthening of patent rights affects the size of the established affiliates and the ownership share held in the foreign affiliates. To isolate the effect of patent protection, we exploit variation of patent protection across countries and time, as well as variation of the dependency on patent protection across sectors and time. A firm's dependency on patent protection is approximated by sector-specific measures of R&D intensity and the perceived effectiveness of patent protection for protecting innovation. By conditioning on an extensive set of fixed effects, we account for unobserved firm- and country-specific heterogeneity and capture potential omitted variable bias. We find that patent protection affects German foreign direct investment in different ways. Strengthening patent protection positively affects the location decision of German multinationals. Furthermore, we find significant nonlinear effects in a host country's initial legal and economic development. With regard to the intensive margin, we find some evidence for a positive effect of patent protection. However, the effect is much weaker than for the location decision. For the ownership shares held in foreign affiliates, we find that average ownership shares increase significantly after strengthening patent protection. The analysis complements and contributes to the previous literature on the relation between intellectual property right (IPR) protection and FDI in different manners. It provides the first firm-level evidence on German multinationals. Insights into how German multinationals are affected by international patent protection are particularly interesting, since Germany is second in the ranking of FDI outward countries (UNCTAD, 2011). Further, the analysis provides a strong identification strategy that allows for nonlinear effects of patent protection and considers various sources of omitted variable bias. Additionally, we take into account host countries' previous levels of legal and economic development, which enables us to draw more precise policy recommendations for reforming countries. Finally, the analysis provides a comprehensive firm-level analysis of FDI decisions at various levels of FDI, something which has been missing in previous research.