This paper examines the long-standing theory that the growth of small firms is often constrained by the quantity of internal finance. Under plausible assumptions, when financing constraints are binding, an additional dollar of internal finance should generate slightly more than an additional dollar of growth in assets. This quantitative prediction should not hold for the relatively small number of firms which access external equity. We test these predictions with a panel of more than 1, 600 small firms and find that the growth of most firms is constrained by internal finance. Our results have implications for several different research literatures, including models of firm growth.

Charles P. Himmelberg, Bruce C. Petersen, R & D and Internal Finance: A Panel Study of Small Firms in High-Tech Industries, The Review of Economics and Statistics, Vol. 76, No. 1 (Feb., 1994), pp. 38-51

We study how firms engaged in both R&D and fixed investment manage liquidity and adjust real investment during the recent financial crisis. Among firms with positive R&D expenditures, cuts to fixed investment in the crisis are typically far more severe than cuts to R&D. These firms allocate cash reserves to buffer R&D but do not use cash to protect fixed investment. Some firms appear to go so far as to allow the stock of fixed assets to fall to stabilize R&D. The use of cash holdings and fixed assets to protect R&D is particularly strong among firms most likely to face financing frictions at the start of the crisis. We only find evidence that firms use cash to buffer fixed investment when we expand the sample to include firms with no R&D spending to compete for funds. Our study provides direct evidence on the real effects of liquidity management, highlights a key benefit of precautionary cash reserves, and illustrates the adjustments firms make to navigate a financial crisis.

The authors reply to the comment by D. R. Kamerschen and J. Park on their 1988 paper published in this Review. They find that the econometric point raised by these authors is flawed, because differences in model structure and data are ignored. In particular, the importance of materials input in assessing price-cost margins is reiterated here and illustrated with the 1988 paper's original table. Other points of the comment are refuted by direct reference to statistical results and inferred conclusions in the 1988 paper.

The relevance of imperfect competition for models of aggregate economic fluctuations has received increased attention from researchers in both macroeconomics and industrial organization.Measuring properly the size of industry markups of price over marginal cost is important both for assessing the role of market structure and for determining the extent to which excess capacity is a significant feature accompanying imperfect competition in American industry.Using a panel data set on four-digit Census manufacturing industries, this paper expand8 recent work by Robert Hall on the importance of market structure for understanding cyclical fluctuations.We outline a methodology for estimating industry markups of price over cost and the influence of market structure on cyclical movements in total factor productivity.While we find evidence to support the proposition that price exceeds marginal cost In U.S. manufacturing, our results offer only limited support for the notion that markups are importantly related to differences in Industry concentration, though the effect of unionization is important.Concentration effects are important only in industries producing durable goods or differentiated con8umer goods.In addition, much of the estimated markup of price over marginal cost is accounted for by fixed costs related to overhead labor, advertising, and central office expenses; we do not find compelling evidence of substantial evidence of excess capacity in most industries.

The sharp increase in R&D investment in recent decades has important but unexplored implications for corporate liquidity management. Because R&D has high adjustment costs and is financed with volatile sources, it is very expensive for firms to adjust the flow of R&D in response to transitory finance shocks. The main contribution of this paper is to directly examine whether firms use cash reserves to smooth their R&D expenditures. We estimate dynamic R&D models and find that firms most likely to face financing frictions rely extensively on cash holdings to smooth R&D. In particular, our estimates suggest that young firms used cash holdings to dampen the volatility in R&D by approximately 75% during the 1998–2002 boom and bust in equity issues. Firms less likely to face financing frictions appear to smooth R&D without the use of costly cash holdings. Our findings provide new insights into the value of liquidity and the financing of intangible investment, and suggest that R&D smoothing with cash reserves is now important for understanding cash management for a substantial fraction of publicly traded firms.

We explore the importance of new public firms and public equity finance for R&D and creative destruction in the US high-tech sector. Over 1900 new public firms enter high-tech manufacturing between 1970 and 2004; they are increasingly R&D intensive and rely extensively on public equity finance in the 1980s and 1990s. We estimate dynamic R&D models and find a strong link between public equity finance and R&D for new entrants, but not established entrants or incumbents. Further, recent cohorts of public entrants have a substantial economic impact: by 2000, recent public entrants account for almost half of high-tech sales and more than half of R&D. Variation in the availability of public equity finance has a marked impact on entrant R&D and the rate at which entrants take market share from incumbents. Our findings identify a key channel through which public equity markets facilitate the process of creative destruction.

The study of the investment-cash flow (ICF) sensitivity constitutes one of the largest literatures in corporate finance, yet little is known about changes in the ICF relationship over time, and the literature has largely ignored how rising R&D investment and developments in equity markets have impacted ICF sensitivity estimates. We show that for the time period 1970–2006, the ICF sensitivity: (i) largely disappears for physical investment, (ii) remains comparatively strong for R&D, and (iii) declines, but does not disappear, for total investment. We argue that these findings can largely be explained by the changing composition of investment and the rising importance of public equity as a source of funds, particularly for firms with persistent negative cash flows.

The high-tech sector accounts for the majority of corporate innovation in modern economies. In a sample of 38 countries, we document a strong positive relation between the initial size of the country's high-tech sector and subsequent rates of GDP and total factor productivity growth. We also find a strong positive connection between a country's equity (but not credit) market development and the size of its high-tech sector. Our main difference-in-differences estimates show that better developed stock markets support faster growth of innovative-intensive, high-tech industries. The main channels for this effect are higher rates of productivity and faster growth in the number of new high-tech firms. Credit market development fosters growth in industries that rely on external finance for physical capital accumulation but is unimportant for growth in innovation-intensive industries. These findings show that stock markets and credit markets play important but distinct roles in supporting economic growth. Stock markets are uniquely suited for financing technology-led growth, a particularly important concern for advanced economies.

This study provides new evidence of the importance of financing constraints for explaining the dramatic cycles in inventory investment. We compare the empirical performance of different financial variables (coverage ratio, cash stocks, and cash flow) used in previous research to test for the presence of financing constraints. The comparison is undertaken in a common framework with an identical sample and high-frequency (quarterly) firm panel data. Cash flow is much more successful than cash stocks or coverage in explaining the facts about inventory investment across firm size, different inventory cycles, and different manufacturing sectors.