Estimating the uncertainty-R&D investment relationship and its interactions with firm size

This paper investigates the uncertainty-research and development (R&D) investment relationship and its interactions with firm size by allowing flexibility in the relationships among uncertainty, R&D investment, and firm size. We hypothesize that the uncertainty effect on R&D investment varies by firm size using South Korean firm-level data. Firm-level uncertainty is measured by variation in a firm's sales revenue, and firm size is measured by two proxies: the firm's sales revenue and the firm's number of employees. We find a concave relationship between the uncertainty elasticity of R&D investment and firm size using separate models for the two firm size proxies. The concave relationship is explained by a change in the dominance of the call option effect, then the put option effect, and then again the call option effect as firm size increases. This relationship serves as an empirically informed knowledge base for policymakers to utilize in evaluating government-funded R&D contracts for encouraging R&D investment.