Is R&D cash flow sensitive? Evidence from Chinese industrial firms

We hypothesize that research and development (R&D) is sensitive to cash flow fluctuations due to asymmetric information and agency problems in the credit market. We adopt a variant of the Q model for R&D investment using the value of the firm, physical capital and employment to capture firm fundamentals as proxies for investment opportunities. We add cash flow to this specification, and estimate the augmented model separately for R&D participation and spending decisions using data on Chinese industrial firms for the period 2001-2006. We find that R&D participation and spending are sensitive to cash flow fluctuations, conditional on firm fundamentals. We also find that the cash flow sensitivity of R&D varies across firms depending on ownership.