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.