Knowledge constraints and firm growth

Firms are constrained in growing knowledge capital due to frictions on the transfer of firm-specific knowledge (such as the process of recruiting and training skilled labor). Constrained firms must therefore forgo some positive-NPV projects during their growth. I embed micro-founded knowledge constraints in a q-theory model of a firm with two capital goods, structurally estimate the model, and compare the impact of knowledge constraints with that of financial frictions on firm investment and growth dynamics. I find that knowledge constraints subsume the role of financing frictions in explaining the dynamics of R&D-performing firms. These constraints endogenously yield that some firms have higher returns to R&D investment than to physical investment, with estimated differences within the range found in previous empirical work. Small, growing firms are especially affected by the constraint and consequently are more R&D intensive and have higher returns to R&D than larger firms. JEL classifications : D2, G31, G32, J24, O32 I thank Ron Kaniel (my adviser), Alex Edmans, Olga Itenberg, John Long, Bill Schwert, Erin Smith, Jerry Warner, Toni Whited, and seminar participants at the University of Rochester for helpful ideas and comments. ∗University of Rochester ([email protected], http://kn.owled.ge)