Absorptive capacity and R&D tax policy: Are in-house and external contract R&D substitutes or complements?

Todd A. Watkins, Lolita Anna Paff

Research output: Contribution to journalArticle

11 Citations (Scopus)

Abstract

Firms fund research and development (R&D) to generate commercializable innovations and to increase their ability to understand and absorb knowledge from elsewhere. This dual role and opposed incentive structure of internal R&D create a significant question for both theory and R&D policy: Is internal R&D a complement or substitute for external R&D? We develop a model and novel technique for empirically estimating R&D substitution elasticities. We focus on bio-pharmaceutical and software industries in California and Massachusetts, where tax credit rates changed differently over time for the two types of R&D, creating a natural experiment. The effective tax prices for the two R&D types differ from type to type, firm to firm, state to state, and year to year. This allows us to examine changes in the composition of firms' R&D budgets between in-house R&D and external basic research when the relative tax prices of each category of research change. We find evidence of a substitute relationship both for a sample comprising exclusively small firms as well as for a more general distribution of firm sizes.

Original languageEnglish (US)
Pages (from-to)207-227
Number of pages21
JournalSmall Business Economics
Volume33
Issue number2
DOIs
StatePublished - Jan 1 2009

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Absorptive capacity
Substitute
Tax policy
Tax
Natural experiment
Basic research
Software industry
Innovation
Small firms
Substitution
Elasticity
Incentive structure
Biopharmaceutical industry
Size distribution of firms
Tax credits

All Science Journal Classification (ASJC) codes

  • Business, Management and Accounting(all)
  • Economics and Econometrics

Cite this

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Absorptive capacity and R&D tax policy : Are in-house and external contract R&D substitutes or complements? / Watkins, Todd A.; Paff, Lolita Anna.

In: Small Business Economics, Vol. 33, No. 2, 01.01.2009, p. 207-227.

Research output: Contribution to journalArticle

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