Financing Constraints, Investment, and Financial Reporting

Abstract

The literature on financing constraints has found, as evidence of the existence of financing frictions, that decreases in internal financial resources causes firms to reduce investment activity. However, the literature is inconclusive on the effect of financing constraints on R&D versus capital expenditures. Using a novel setting, this paper finds firms that face a negative shock to internal capital do not uniformly cut back on all types of investment, but allocate capital away from investments with uncertain returns. I use the setting of the 1999 Taiwan earthquake, which disrupted the global semiconductor supply chain and increased production costs for a subset of US high-technology manufacturing firms that sourced semiconductor wafers and other components from Taiwan, causing a drain on internal capital. I find firms negatively impacted by the shock did not cutback on capital expenditures, but reduced R&D investment. In additional analysis, I find affected firms became more aggressive in their revenue recognition practices after the shock, potentially in response to an increase in competition from rivals, or to window-dress financial statements prior to raising equity.