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Faculty of Business and Economics Industrial research versus development investment: The implications of financial constraints Dirk Czarnitzki, Hanna Hottenrott and Susanne Thorwarth DEPARTMENT OF MANAGERIAL ECONOMICS, STRATEGY AND INNOVATION (MSI) OR 0905 Non-technical Summary Industrial research and development (RD) activities constitute an important driver of economic competitiveness. The impact of RD on productivity at the firm level stems from the implementation of newly generated knowledge and technological discoveries into new products, processes or services. Particularly the ‘R’ component of RD has been found to drive productivity at the firm level. That is firms that invest a larger fraction of their total RD on research (relative to development) are more productive both in terms of the production of new knowledge, e.g. patens as well as overall factor productivity. However, economic theory suggests that two types of market failure affect private investments in research. First, private rates of return from research activities are smaller than social rates of return because of the incompleteness of appropriability of the knowledge that is being created by investment. Second, especially for (basic) research firms may face difficulties in attracting external investors or get bank loans for financing these activities. Complexity, specificity and outcome uncertainty of such investment projects may make it particularly difficult for outsiders to judge the expected return of ‘R’ projects. Hence, for firms with