Debt market friction, firm-specific knowledge capital accumulation and macroeconomic implications

This paper studies research and development (R&D) investment and accumulation of firm-specific knowledge capital (i.e., human capital) in the presence of debt market frictions, highlighting the macroeconomic implications. Empirically, R&D investment and knowledge capital are negatively correlated with debt at the firm level, which is in contrast with the positive relationship between physical investment and firm debt. I propose a new model to account for these facts: Firms accumulate firm-specific knowledge capital through R&D investment. However, knowledge capital - different from physical capital - cannot be used as banking collateral. Firms with high R&D investment opportunities rely more on internal finance and less on external debt. The model is quantitatively consistent with empirical facts along several dimensions. Based on the model, I then study the implications of two industrial policies. A practice that encourages using intellectual property as collateral for bank loans has a relatively small effect. I recommend a policy of tax credits for R&D investment. In fact, this policy can increase output by more than 5% and welfare by more than 3% in the long run.