Firm-level R&D after periods of intense technological innovation: the role of investor sentiment

BIS Working Papers  |  No 916  | 
08 January 2021
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 |  43 pages



After a new technology becomes available, firms learn about its productivity by undertaking small-scale test projects. Based on accounting rules, the corresponding costs are booked as research and development (R&D). A company may invest too little in learning about a new technology, for instance when its competitors can observe the outcome of its test projects. In aggregate, firms risk gaining insufficient insights into a technology before deciding whether to adopt it or not.


We study whether investor sentiment, often defined as the propensity to speculate in financial markets, can lead firms to increase R&D after a new technology becomes available. In particular, we are interested in whether the effect of investor sentiment is stronger for companies that are more likely to face constraints that reduce investment in test projects.


We find that investor sentiment reinforces the effect of lagged technological innovation on company R&D, especially in two cases. The first is when a firm's test projects can inform its competitors about the value of the new technology. The second is when a firm's shareholders have short investment horizons. Overall, investor sentiment appears to offset, at least in part, constraints that can diminish a company's incentives to learn about a new technology.


Following periods of intense technological innovation, R&D is a critical driver of technology diffusion, but it is subject to frictions that can lower it below the level firms would undertake otherwise. We study whether sentiment can counterbalance these frictions and thus strengthen the link between firm-level R&D and lagged aggregate innovation. We find a positive answer for low-tech firms, which represent the main conduit for technology diffusion. The effect is stronger in the presence of informational externalities, that is when the results of experimentation funded by a company are observable by competitors. In contrast to the literature on sentiment and capital expenditures, the effect is weaker for financially constrained firms.

JEL Codes: G02, G31, O32, O33

Keywords: investor sentiment, technological innovation, R&D