This paper uses the staggered changes of R&D tax credits across U.S. states and over time as a quasi- natural experiment to examine the impact of innovation on corporate liquidity. By generating plau- sibly independent variation in firms’ incentive to invest in R&D, we are able to assess the empirical importance of specific theories of the link between innovation and corporate liquidity. Firms increase (decrease) their cash to asset ratios by about one and a half percentage point when their home state increases (cuts) R&D tax credits. These baseline difference-in-differences estimates hold up to a bat- tery of validation, falsification, and robustness checks, which corroborate their internal and external validity. The treatment effect of R&D tax credits increases monotonically with several specific prox- ies for debt and equity financing frictions. Increases (cuts) in tax credits also lead to increases (de- creases) in the ratios of cash to bank lines of credit and to book equity, and to decreases (increases) in bank debt, secured debt, and overall net indebtness, supporting debt and equity financing channels through which innovation impacts the demand for cash. We also find support for a product market competition channel, and assess repatriation and agency explanations. Overall, our analysis offers endogeneity-free evidence that innovation is a first-order driver of corporate liquidity management decisions.
