R&D investments, financial imperfections and the business cycle. Evidence from Italian firms during the crisis

We analyze empirically the relationship between financial imperfections and firms’ R&D expenditure over the business cycle, using an Italian firm-level dataset based on survey data on innovation and balance sheet information over the period 2004-2010. We explore how R&D investments’ decisions change prior and after the credit crunch of 2008 also focusing on the effect of firms’ financial vulnerability measured by the Whited and Wu index. We show that when financial markets are perfect, i.e. low credit rationing and low financial vulnerability, R&D expenditure is counter-cyclical fostering the important role of mitigating fluctuations over the business cycle. On the other hand as firms face tighter constraints and/or higher financial vulnerability, R&D investments become pro-cyclical amplifying the effects of the business cycle.