Technology spillovers and corporate cash holdings

Jiaping Qiu, Professor, Finance and Business Economics | Hamilton, ON | May 15, 2015

applevssamsungInnovation in technology is important for firms to achieve a competitive advantage and experience growth in productivity. Technology spillover refers to the benefit of new technology on productivity and innovation to other firms. Technology spillover allows rival companies to acquire technology at a lower cost than inventing their own, which can improve productivity and prompt further innovation. At the same time, innovation can threaten the product market as it strengthens the innovator’s competitive advantages and changes market share. It is important for firms to keep a liquid balance sheet in order to compete, which allows the firm to benefit from technology spillover and react accordingly to competition.

In recent news

Technology spillover, product market rivalry, and corporate liquidity management are all issues in the dispute between Apple and Samsung. In 2011, Apple sued Samsung for patent infringement stating that the Samsung Galaxy line and tablet computers copied the iPad/iPhone design. Samsung countersued.

This lawsuit highlights features of technological competition. The concept of “coopetition” refers to when firms compete for market share they learn from each other and collaborate on ideas. In this case, technological innovation is important because both Apple and Samsung are highly profitable and thrive on technological advantages. One company’s innovations can help the other company innovate further by building upon those ideas.

What did the study find?

1. Technology spillovers and market competition increase the amount of cash the firm holds

The study finds that both technology spillovers and market competition can positively affect firm’s cash holdings. The product market rivalry effect is measured by sales-weighted average of company’s research and development stocks, which considers the business stealing effect due to competitors’ technological advances.

2. When a firm sees that a competitor is investing in research and development, the firm tends to save more cash so they can react to unexpected expenses and take advantage of unforeseen opportunities

The study estimates that firms increase their cash-to-assets ratio by 7.6% from when technology spillover occurs to the third quartile. This suggests that when competitor’s research and development is applicable to a firm’s own technology, the firm tends to hold more cash to preserve financial flexibility.

3. Technology spillover has more of an impact on the cash holdings of firms that are more profitable, face more growth opportunities, have younger patents, and have more market fluidity

The study examined sub-samples of firms that are likely to benefit more from competitor’s innovations. If a firm could profit from their competitor’s innovations then holding cash for technology spillover is more beneficial. Technology spillovers can improve the innovation productivity of the firm’s own research and development.

If the firm anticipates that the innovation could lead to increased sales and higher profit to the firm, then there is greater incentive to build cash reserves to eventually boost production of the improved product. Therefore, technological spillover is more beneficial for the firms who anticipate higher profit margin.

The study finds that the impact of technology spillovers on cash holdings are stronger for firms that are more profitable, face better growth opportunities, have younger patent ages, and are associated with greater product market fluidity. This supports the notion that a firm’s incentive to reserve cash for spillovers depends on the usefulness of the innovation to increase profit because of the improved product.

4. Technology spillover and market competition has a substantial impact on firms that are financially constrained

Technology spillover and market rivalry effects are more pronounced for financially constrained firms, namely, those with poor credit ratings, smaller sizes or higher values of leading indices for constraints. The finding indicates that a firm with smaller market share requires more cash to fund future investment needs in both technology and product market dimensions.

5. Firms with successful research and development initiatives who do not patent also increase the amount of cash held when there is competition and technology spillover

Non-patenting firms who invest in research and development are exposed to technology spillovers and competition caused by innovations of patenting firms. The study finds that non-patenting firms, who have been successful in research and development, also increase cash holdings in response to technology spillovers and product market rivalry.

What do these results imply?

Technology innovations and spillovers are important for long-term economic growth. Technological competition, particularly technology spillovers, changes a firm’s cash holdings. A firm’s cash balance increases more when the firm is financially constrained. A firm’s cash balance also increases significantly when the innovation can increase the firm’s profit through increased production of the improved product. These results imply that technology spillover has a big impact in determining corporate cash policy.

jiaping-quiProfessor Qiu has broad research interests in corporate finance, capital market and household portfolio choice. His current projects include liquidity in CDS market, competition in the mutual fund industry and human capital loss in corporate bankruptcy.

Professor Qiu is also the CIBC Chair in Financial Markets (appointed July 2012).

 

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