External financing sensitivities and inefficient R&D investment: Evidence from China

This study presents how a firm's abnormal research and development (R&D) investment affects its external financing sensitivity. Using data from Chinese listed firms from 2009 to 2020, we find over-investment in R&D firms exhibits lower bank loan financing sensitivity to Tobin's Q (Q) and greater trade credit financing sensitivity to free cash flow. We attribute this finding to a phenomenon that managers (controlling shareholders) expropriate resources from shareholders (minority investors), which leads to increased cost of external debt finance by the firms it faces when the agency problem is growing worse. There is no evidence that supports the managerial motivations of financial constraints and real earnings management used to explain the differential external financing sensitivities to Q and free cash flow of firms with either over-investment in R&D or under-investment in R&D. Our findings are robust to using alternative model specifications, considering internal wealth variables, and executing the test for endogeneity.