​We found the relative status of an affiliated firm in a business group as key channels that affect the firm’s R&D investment decisions.

“R&D Investment Decisions in Business Group: Evidence from a Natural Experiment, SH Choi, DW Choi, YK Gam and HJ Shin, Corporate Governance: International Review, October 2021”

• Corporate Governance: International Review
• Publication date: October 2021
• DOI to Review Case Study

Corporate R&D investments are heterogeneous across firms even within the same business group. What kinds of drivers differentiate R&D expenditures among companies within the same business group? A large body of literature focuses on firm- or industry-level characteristics such as growth potential, industry structure, and corporate governance to explain the heterogeneity of R&D investment patterns across firms. This study concerns a pyramidal ownership structure of a business group and the relative status of an affiliated firm in the pyramid as key channels that affect the firm’s R&D investment decisions.

By employing the difference-in-differences (DiD) approach, we provide empirical evidence from a quasi-natural experiment that the equity investment regulation positively affects R&D investment decisions of the Korean chaebol firms. The new equity regulation places limits on group affiliates’ equity investments up to 25% of their net assets and requires controlling owners to reallocate the excess equity investments. Our results show that, after the new regulation, the controlling owners are more likely to increase long-term R&D expenditures in firms for which the equity investment ceiling is applied. Moreover, we find that this trend of increasing investments is more profound in firms for which controlling owners have lower cash-flow rights. This trend, however, is less likely in the firms located in the upper layer of the pyramid, where the controlling owners’ direct ownership is highly concentrated, and in high-centrality firms for which equity investment in group affiliates is highly preferred for governance purposes. Overall, this study highlights the heterogeneous effects of the regulatory reform on R&D expenditures across firms with different positions under a pyramidal ownership structure.

Our findings provide several important implications for policymaking. Our results provide novel insight into the positive policy implications of the equity investment regulation on R&D investments for business groups. We further highlight that the regulatory effects on firms’ investments are not uniform but quite heterogeneous across firm types within the business group. Exactly how to minimize potential blind spots created by the heterogeneous policy effects is an important question for policymakers.