Working Paper: NBER ID: w0931
Authors: Mark Schankerman; M. Ishaq Nadiri
Abstract: This paper proposes a framework which integrates convex costs of adjustment and expectations formation in the determination of investment decisions in R&D at the firm level. The model is based on cost minimization subject to the firm's expectations of the stream of output and the price of R&D, and results in equations for actual and multiple-span planned investment in R&D and for the realization error as functions of these expectations. The model accommodates alternative mechanisms of expectations formation and provides a methodology for testing these hypotheses empirically. We derive estimable equations and testable parameter restrictions for the rational, adaptive and static expectations hypotheses. The empirical results using pooled firm data strongly reject the rational and static expectations hypotheses and generally support adaptive expectations.
Keywords: R&D investment; expectations formation; costs of adjustment
JEL Codes: O32; D24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal cost of adjustment in R&D (O39) | anticipated price of R&D (O32) |
| shadow price (D41) | expected demand for output (E23) |
| firms' expectations (D84) | realization of planned versus actual R&D investments (O32) |
| discrepancies between planned and actual R&D (O32) | revisions in expectations over time (D84) |
| optimal level of planned R&D (O32) | equating marginal cost of adjustment to shadow price of R&D (O39) |
| shadow price of R&D (O39) | expected future economic conditions (E66) |