R&D Tax Credits and R&D Investment Efficiency : International Evidence

We examine the effect of country level research and development (R&D) tax credits on optimal levels of firm-specific R&D investments. We use a sample of R&D active firms from 22 countries and find that such credits drive firms to invest towards optimal levels of R&D investment. This finding is particularly present in those firms which invest in R&D above optimal levels and in firms that are invest heavily in R&D. Further, our findings hold only in jurisdictions with weaker accounting enforcement and for firms with lower institutional ownership. We interpret these results as indicative of R&D tax credits promoting optimal R&D investment levels for firms in contexts where other mechanisms that should favor optimal R&D investment are weaker. Finally, we find that R&D tax credits strengthen the positive association between R&D investment and firms’ accounting and market performance for our full sample and for firms that tend to over-invest in R&D. These findings indicate that optimized levels of R&D investment incentivized by tax credits positively reflect on future profitability and this positive outcome is also reflected on market appraisal. Our study makes significant contributions to both the tax and the financial accounting strands of the literature and its findings raise important policy implications