DP14152 Knowledge Cycles and Corporate Investment

Author(s): Maria Cecilia Bustamante, Julien Cujean, Laurent Frésard
Publication Date: November 2019
Keyword(s): Experimentation, exploration, Information Aversion, Intangibles, investment, Knowledge
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14152

We propose a theory of how the process of knowledge creation within firms affects their investment decisions. Firms accumulate knowledge through successive rounds of experimentation in the form of capital expenditures, and reset knowledge when they explore new technologies. This process generates endogenous knowledge cycles, which govern firms' investment. Because risky experimentation makes firms information averse, investment increases but Q decreases as knowledge accumulates. The relationship between investment and Q thus varies over the knowledge cycle and is strongest early in the cycle. We find empirical support for the knowledge channel using a text-based measure of knowledge cycles from public firms. The knowledge channel could explain why investment has been weak in recent years despite high valuation.