Opinion: German companies have unique options to continue investing in research and development despite the Corona crisis
Dries Faems: April 20, 2020
As in most countries, German companies are facing huge challenges because of the Corona crisis. Both start-ups and established companies face significant disruptions in their business model, leading to substantial reductions in revenues, which can threaten the survival of the company. In these extremely challenging times, it can be tempting for companies to cut back on long-term investments such as research and development (R&D). Nevertheless, I want to make a strong claim for maintaining R&D investments in this crisis period. Moreover, I highlight that German companies can substantially benefit from the recently introduced Research Incentives Act to reduce the costs of such sustained R&D efforts.
Why German companies should continue investing in innovation
Although the Corona crisis has some unique characteristics, it is not the first crisis that substantially affects economic activity. Luckily, academic scholars have used prior economic and financial crises to study the impact of R&D investments on the short-term and long-term performance of the firm. The results of these studies are rather consistent.
Studying 600 publicly listed companies during the tech-crisis in 2001/2002, colleagues from the Rotterdam School of Management, for instance, found that, in the short-term, companies that continue investing in R&D during the crisis tend to financially perform worse than companies that cut back on R&D as their cost levels tend be higher (1). However, in the long-term, companies that continued investing in R&D significantly outperformed companies that scaled back R&D. Considering a four year period after the crisis, they found that, on average, the stocks of companies, which did scale back R&D during the crisis, increased with 57%. However, companies, which had sustained R&D during the crisis, experienced an average stock value increase of 300% in the long term.
Similar results are found at the country level. Scholars at ZEW, for instance, studied the R&D spending behavior of different European countries (2). They observed that so-called innovation leaders (e.g. Germany, Sweden, Finland) apply a counter-cyclical R&D public spending strategy, meaning that these countries intensify R&D spending during recession periods. Countries that are labeled as moderate innovators (e.g. Spain, Greece), in contrast, apply a pro-cyclical R&D spending strategy. These latter countries reduce public R&D is substantially during recession times and try to catch-up R&D spending during non-recession times. Together, these findings suggest that maintaining investing in R&D during crisis times is an important path for future success.
How should German companies continue investing in innovation
At the same time, we cannot ignore the cost aspect of investing in R&D. However, German companies can substantially benefit from the recently introduced Research Incentives Act (i.e. Forschungszulagengesetz) to minimize the costs of R&D investments. At the beginning of 2020, this Research Incentives Act has been introduced by the German government to boost innovation. Nowadays, it might turn out to be an extremely valuable tool for many companies to continue investing in R&D during these challenging times. Within the framework of the Research Incentives Act, German companies can receive tax benefits for particular R&D projects. These research and development projects must be assignable to one or more than one of the following categories: fundamental research, industrial research or experimental development (3).
When companies use their own research staff for this kind of R&D projects, 25% of wages and salaries will be offset against the annual tax demand. Moreover, companies can also profit from this concession during loss phases, making the incentive scheme attractive to start-ups and other entrepreneurs who are not yet making profits. Finally, companies can even apply this tax scheme for commissioned research. When companies outsource R&D projects to contractors, they can still receive of tax benefit of 15%.
In sum, the Research Incentives Act can help German companies to reduce the costs of current R&D investments, which can be an important driver of future success. I therefore encourage every German CEO to call their accountant to make sure that they optimally benefit from this important and attractive tax incentive.
Do you want to know more about how companies can stimulate innovation in these challenging times? Please check my WHU webinar on ‘Leveraging innovation opportunities in times of Corona’ via the following link: https://whu.cloud.panopto.eu/Panopto/Pages/Embed.aspx?id=60e9e246-1cbf-4818-8f13-ab9701153d7c&autoplay=false&offerviewer=true&showtitle=true&showbrand=false&start=0&interactivity=all
1. https://www.youtube.com/watch?v=Xx-meYSX8cA
2. http://ftp.zew.de/pub/zew-docs/dp/dp18005.pdf
3. https://www.bdo.de/en-gb/insights/updates/tax-legal/r-d-tax-incentive-in-germany