Question

Investment in R&D is considered to be risky, since it is subject to both market and technology uncertainties that along with the resulting asset-specificity of R&D investment may hinder firms’ access to debt financing. Using the Transaction Costs Economics (TCE) approach and any other concepts from Chapter 8, predict the relationship between a firm’s innovation strategy (spending on R&D) and external financing (e.g., the more the firm focuses on innovation, will it result in more or less debt from banks and why?).

Answer 1

It is true that the relationship is direct enough between bank loans and expenditure on Innovation. Innovation has always downside risks of failure and market acceptance. Firms tend to seek first mover advantages and test various technologies to check each use cases and hence capex is higher whichbmeans firms tend to borrow more. Also returns generated on newer technologies is relatively less in short run as consumers willingness to buy is low because of high prices. This result in lower ROI and hence debt piles up.

However if firm has enough cash flows and is involved in JV or Merger or Acquisition then cost of a innovation becomes substantially less.

For example when Vodafone tests its 5G trials the cost of equipment and manpower and product management is higher. However when it shares resources with local providers JV through JV the cost is lower and hence debt is much lower.