Does Government Spending Crowd Out R&D Investment? Evidence from Government-Dependent Firms and Their Peers

Abstract

We provide evidence that managerial incentives to manipulate real activities can influence the effectiveness of fiscal policy. Increases in federal spending lead government-dependent firms to expand research and development (R&D) investment whereas industry-peer firms contract. The net result is a reduction in industry-level R&D investment. We find evidence of a novel mechanism for the crowding out of peer-firm investment: peer-firm managers respond to falling relative performance by cutting R&D to manage current earnings upward. We show that these differential responses manifest in firm value. These findings are robust to endogeneity and selection concerns as well as a battery of alternative explanations.

Cross-Subsidization in Conglomerate Firms: Evidence from Government Spending Shocks

“…Because input-output tables are at the industry level, our government dependency constructed above has no variation within each industry year. Brogaard, Denes, and Duchin (2021) and Ngo and Stanfield (2022) show that firms within an industry vary in their fraction of sales to the government. Therefore, relying solely on input-output tables may misclassify the government dependency of some segments.…”

“…We interact government dependency (OWN_GD, OTHER_GD, or FIRM_GD) with government spending in the previous year and use this interaction as our measure of government spending shocks in the empirical analysis. As noted in Ngo and Stanfield (2022), the formal budget process for discretionary spending starts when the President submits a detailed budget request for the coming fiscal year (which begins on Oct. 1) by early February to Congress. Congress then considers the annual appropriations bills, which set the budget authority for the coming fiscal year.…”

“…While contemporaneous spending from the government may be endogenous, the lagged spending is less likely to be so. As noted in Ngo and Stanfield (2022), discretionary federal outlays in a year are dictated by the budget authority passed by Congress in the previous year. Therefore, the outlays in the previous year, which we use to construct our measure, are dictated by budget authority passed by Congress 2 years ago, which is even less likely to be correlated with contemporaneous economic conditions.…”

“…Therefore, the outlays in the previous year, which we use to construct our measure, are dictated by budget authority passed by Congress 2 years ago, which is even less likely to be correlated with contemporaneous economic conditions. Third, we use the party affiliation of the executive branch and the legislative branch of the federal government as an instrument, which is motivated by Ngo and Stanfield (2022). Because our spending measure focuses on nondefense discretionary outlays, we use a dummy variable, DEMOCRAT, which indicates if the executive branch and at least one chamber of Congress are under the control of Democrats, as the instrument.…”

“…Finally, we use an instrumental variable (IV) approach to address the endogeneity issue of government spending. Specifically, we use the political party affiliation of the executive branch and the legislative branch of the federal government as an instrument, which is motivated by Ngo and Stanfield (2022). Because our government spending shocks focus on nondefense discretionary spending, we use a dummy variable indicating if the executive branch and at least one chamber of Congress are under the control of Democrats as our instrument.…”