R&D Tax Credits, Financial Constraints, and R&D Investments

Research and development (R&D) expenditures are affected potentially by the present and past use of R&D tax credits through two channels. While the present use of R&D tax credits promotes R&D investment through a reduction in capital cost, the past use promotes the investment through an increase in internal funds. We empirically investigate how these two channels affect the R&D investment of Japanese manufacturing firms by using firm-level data. Our results can be summarized as follows. First, the effect of the present use of R&D tax credit on R&D investment is smaller for firms that are more likely to depend on external finance (i.e., firms that operate in industries with higher dependence on external finance) than for those that are less likely to depend on external finance, suggesting that higher agency cost associated with the larger use of external finance partially mitigates the effect of R&D tax credits. Second, the past use of R&D tax credits does not necessarily lead to significant increase in the internal funds for firms that are more likely to depend on external finance, which implies that the use of R&D tax credits does not contribute to the promotion of firms' R&D investment. These results jointly imply that the effect of R&D tax credits on R&D investment is limited for financially constrained firms.