Essays in Financial Economics

Huang, Qiushi

doi:https://doi.org/10.21985/n2-sqnw-zn86

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Essays in Financial Economics

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Technological innovation is a key determinant of economic growth, and my dissertation is to understand the links between the investment of technological innovation and financial markets, with a focus on how the macroeconomic environment interacts with and is influenced by the financial constraints facing firms. Chapter one investigates the links between tax rate on cash, firms' preference for risky investments and the level of industrial concentration. To the extent that investment in innovation is inherently risky, this study sheds light on how the change of foreign tax rate, together with the tax avoidance behavior, might have unexpectedly affected the R&D investments of U.S. firms, and more surprisingly, the concentration level of the industry. The key result in this chapter is to show that foreign tax rate might have shaped the industrial concentration in the past two decades, by affecting firms' financing-induced preference for risky investments such as R&D and mergers and acquisitions. The mapping from the foreign tax rate to the level of concentration consists of three parts. First, risk-neutral firms behave as if they were risk-averse because of the consideration of the possibility of being financial constrained. Second, this financing induced risk-aversion is influenced by the foreign tax rate, so that firms invest more in risky investment when the rate becomes lower. Third, ex-ante risks, after the resolution of uncertainty, manifest themselves as ex-post dispersion, which gives rise to an increase in the level of industrial concentration. The proposed theory received empirical support: (i) The aggregate cash balance has been rising in the same period. The rise is mostly accounted for by the multinational firms, stressing the importance of foreign tax rate; (ii) Multinational firms increase their R&D expenditure relative to non-multinational firms; (iii) If ex-ante risks manifest themselves as ex-post dispersion, we should expect multinational firms to have a higher dispersion than non-multinational firms. this conjecture is confirmed in the data. Chapter one proposes a theory of how a particular aspect of the macroeconomic environment, industrial concentration, can be influenced by the change in firms' financial constraints. In the opposite direction, macroeconomic environments such as aggregate innovation can also affect firms' financing capacity. Chapter two -- "External finance, firm R&D and Economic Growth" considers such two-way interaction between innovation and firms' external finance, and studies how financial market contributes to economic growth by financing firm-level R&D investment. Specifically, the paper focus on the following interaction between R&D and external finance: External finance facilitates R&D investments, but R&D investments change the composition of physical capital towards fast-depreciation assets, which leads to lower collateral value and hence decreases firms' external financing capacity. The obsolescence channel might also affect the types of projects that firms want to invest in. That is, do innovation investments affect tangible investments? What is the impact of the by-product of innovation-- technological obsolescence on entrepreneur's tangible investment decision? Chapter three--"Technological Innovation and Financing frictions" shows that when the obsolescence rate is considered, entrepreneur invests more in innovation as the return from investing in physical capital becomes lower, which is referred to as the "Momentum of Innovation". In the model, industries with less technological progress are more likely to pay out dividends. The economy can exhibit multiple equilibria, with entrepreneurs' expectations determining which equilibrium obtains: if firms expect future obsolescence to be high, they invest more in innovation as physical investments will be worth less tomorrow, which fulfills their expectations of the obsolescence. On the other hand, debt financing facilitates innovation, but also creates a self-sustained friction when entrepreneurs are financially constrained: a higher level of innovation lowers the value of existing capital, which in turn affects the debt capacity of firms and stifles further technological progress.

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