Scandinavian Working Papers in Economics

Working Paper Series in Economics and Institutions of Innovation,
Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies

No 72: Investment and Performance of Firms: Correlation or Causality?

Almas Heshmati () and Hans Lööf ()
Additional contact information
Almas Heshmati: CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology, Postal: CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology, SE-100 44 Stockholm, Sweden
Hans Lööf: http://www.infra.kth.se/cesis/cesis/index2.htm, Postal: CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology, SE-100 44 Stockholm, Sweden

Abstract: The purpose of this paper is to provide empirical analysis of the two-way causal relationship between some important investment and performance indicators at the firm level, in particular controlling for differences in these relationships between two cohorts of small and middle-sized firms and large firms respectively. Investigated performance variables include sales, value added, profit, cash flow, capital structure and employment. A multivariate vector autoregressive approach is applied to a panel of Swedish firms observed between 1992 and 2000. In particular, an attempt is made to investigate whether causal relationships between R&D and firm performance are of a transitory nature and whether the causal relationships are similar for small and medium-sized and large firms. Results show evidence of some two way causal relationships, which are mainly transitory in character. Significant heterogeneity is observed in the firms’ investment and performance behavior by their size.

Keywords: R&D investment; productivity growth; financial constraints; panel data

JEL-codes: C23; C33; G32; L19; O33

33 pages, August 3, 2006

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