Government Spending, Consumer Demand, and Firm Innovation

We show that the extent to which government spending hinders private sector innovation is highly dependent on a firm's revenue sensitivity to consumer demand. The effects are stronger for firms that are more dependent on internal financing to fund innovative activity such as firms with high intangible assets and low cash flows. Managers respond to declines in earnings by reducing investments and increasing cash holdings. Firm payouts and external financing remain largely unaffected. We show that the consumer demand channel operates independently of the resource diversification and crowding out mechanisms documented in prior studies