“Product market competition and a firm’s R&D investment: New evidence from Korea”

This study aims to examine the effect of product market competition on a firm’s invest- ments in research and development (R&D) and how this effect varies depending on the firm’s internal corporate governance. This study employs the regression method to analyze the association between product market competition and a firm’s R&D investment. Since product market competition works effectively as an external corporate governance mechanism that reduces agency problems and information asymmetry, this study hypothesizes that a competitive product market promotes R&D investments. Using 11,560 firm-year observations of Korean listed firms for 2001–2020, this study finds a positive association between product market competition and R&D investment. The result also shows this association is more pronounced for firms with weak internal corporate governance mechanisms. Furthermore, additional analysis shows that the effect of product market competition on a firm’s R&D investment is stronger for firms in the low-tech industry. This study provides new insights on the inconclusive associa- tion between product market competition and a firm’s R&D investment and practical implications that product market competition drives firms to invest in R&D. long-term firm the various determinants of firms’ R&D investments, the association between market structure and R&D investments a central considerable both and the association between market structure and firms’ R&D investments could provide practical implications for business strategies and


INTRODUCTION
This study investigates the association between product market competition and a firm's research and development (R&D) investments. It is well established that a firm's technological improvement and innovation are the key factors that drive long-term economic growth, as well as the firm's future performance and sustainability (Kuznets, 1966;Romer, 1990;Schumpeter, 1939). Investments in R&D by firms have increased dramatically in recent decades due to the rapid development of technology. Additionally, the increasing importance of a firm's innovative activities and R&D investments has attracted the attention of both researchers and market participants.
Many studies seek determinants of a firm's investments in R&D, considering the significance of R&D investments in fostering long-term firm and economic growth. The literature shows that both firm-and market-level factors influence firms' R&D investments, such as firm size, financial health, ownership structure, market structure, and government regulations (AlHares, 2020; Baldi & Bodmer, 2018;Bhagat & Welch, 1995;Spulber, 2013). Among the various determinants of firms' R&D investments, the association between market structure and firms' R&D investments has been a central theme and has drawn considerable attention from both academics and regulators, since the association between market structure and firms' R&D investments could provide practical implications for business strategies and market policies.
There is much literature on the association between market structure and a firm's R&D investments. Specifically, many studies focus on the effects of product market competition or concentration on a firm's R&D activities to answer the question of whether market competitiveness promotes or depresses a firm's investments in R&D (Arrow, 1962;Blundell et al., 1995;Geroski, 1990;Gu, 2016;Nickell, 1996;Schumpeter, 1943). However, both theoretical and empirical studies on the association between market competition and a firm's R&D investments show mixed and conflicting results owing to the use of different theoretical models, empirical methods, and data limitations.
According to the literature, product market competition is an effective external governance mechanism that contributes to reducing information asymmetry and agency problems through the disciplinary threat of survival or failure to both executives and firms (Byun et al., 2012;Grullon & Michaely, 2007;Shleifer & Vishny, 1997). The literature on a firm's R&D investments indicates that corporate governance is also a key determinant of a firm's R&D activities ( Yoo & Sung, 2015). They provide empirical evidence that corporate governance, such as board independence, ownership structure, and anti-takeover devices, significantly affects a firm's R&D investments by reducing agency problems and information asymmetry. Given that product market competition is an effective corporate governance mechanism that reduces information asymmetry and agency problems, product market competition is likely significantly associated with a firm's R&D investments.
The remainder of this paper is organized as follows. Section 1 provides a literature review and hypotheses development. The research design and methods are presented in Section 2. Section 3 discusses the study's results. Finally, the last section concludes the paper.

LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT
A large body of research shows that a firm's R&D investments and technological competencies are key factors of sustainability and long-term growth for both firms and economics (Honoré et al., 2015;Kuznets, 1966;Romer, 1990;Schumpeter, 1939). Furthermore, the rapid development of technologies and changes in the market environment make a firm's R&D investment even more important (Lv et al., 2019;Rodrigues et al., 2020). Thus, many studies seek to identify the key determinants of a firm's R&D investments.
Among various factors affecting a firm's R&D investments, prior research examines the association between product market competition and a firm's R&D investments. However, theoretical and empirical studies often show mixed and conflicting results. For example, Schumpeter's (1943) early theoretical research contends that higher market concentration and monopolies promote innovations by reducing uncertainty and creating stable cash flows to finance R&D investments. In contrast, Arrow (1962) shows the theoretical background that market competition promotes a firm's innovation. Moreover, Scherer and Ross (1990) document that competition is a key driver of a firm's innovation and growth because it induces firms to innovate to survive and prevents bureaucratic inertia, which discourages innovation.
Several empirical findings on the effects of various forms of market competition on a firm's R&D investments also show mixed results. Early research by Horowitz (1962) proves that competition discourages a firm's R&D investments. Similarly, Blundell et al. (1995), using a sample of UK-listed firms, show that market-dominant firms are more likely to innovate, indicating that lower market competition promotes a firm's innovation. Other studies, such as Kraft (1989) and Crepon et al. (2006), support the idea that there is a negative association between market competition and a firm's innovation activities. More recently, research by Gu (2016) argues that high market competition may reduce a firm's R&D investment because resources to finance a firm's R&D projects are more likely to be extinguished in a competitive market. There are also several empirical studies supporting the idea that high product market competition positively affects a firm's R&D investments. Using UK data, Geroski (1990) provides evidence that high market concentration and monopoly power decrease a firm's innovation, implying that lower market competition discourages R&D activities. Nickell (1996) and Blundell et al. (1999) also support the positive association between product market competition and a firm's innovation. Similarly, recent research by Van Vo and Le (2017) proves that firms in a competitive market are more likely to invest in R&D projects to obtain a competitive advantage because highly competitive markets face more threats to exit from the market.
In summary, previous studies on the association between product market competition and a firm's R&D investments show mixed and conflicting results. Moreover, extant research focuses on the effect of product market competition on risk, uncertainty, rents, and resource allocation when analyzing and interpreting the effect of product market competition on a firm's R&D investments.
The success of R&D investments brings about large benefits and superior performance for firms. However, R&D investment is a long-term business activity with features of high uncertainty, risk, and low possibility of success (Driver & Guedes, 2012;Lv et al., 2019). In agency theory, shareholders are considered risk-neutral because they can spread their risks. However, managers are treated as riskaverse because their probabilities of turnover and compensation depend on firm performance. In addition, in agency theory, managers can only apply their efforts to one job. Therefore, managers prefer short-term gains derived from efficiency-seeking strategies, creating conflicts of interest between managers and shareholders. Information asymmetry also hinders shareholders from monitoring managers effectively and aligning managers' and shareholders' interests.
Collectively, the features of a firm's R&D investments and agency theory clearly imply that there are conflicts of interest between managers and shareholders in R&D investment decisions, since the purpose of managers is to maximize their own interests and secure their jobs. While the main objective of shareholders is to maximize the value of the firm, managers are more likely to underinvest.
Corporate governance refers to a set of internal and external disciplinary and control mechanisms that reduce conflicts of interest and information asymmetry between managers and shareholders, resulting from the separation of ownership and control (Shleifer & Vishny, 1997). Corporate governance comprises monitoring managers and incentives that reduce their self-serving behavior. A large body of research has documented that corporate governance promotes a firm's R&D investments by reducing agency problems and information asymmetry For instance, Dong and Gou (2010) documented that managerial discretion, ownership structure, and independent outside directors are significantly associated with a firm's R&D investments. Similarly, Rodrigues et al. (2020) argue that board characteristics such as board size, independence, and tenure significantly affect a firm's R&D investments. AlHares (2020) also provides evidence that institutional ownership, board size, board independence, and board diversity are critical factors that affect a firm's R&D investments.
It is well established that product market competition is one of the most effective disciplinary corporate governance mechanisms that reduce information asymmetry and agency problems by aligning the interests of the managers with shareholders (Alchian, 1950;Griffith, 2001;Schmidt, 1997; Shleifer & Vishny, 1997).
For example, Griffth (2001) shows that managers are subject to higher default risk and turnover in a competitive market, forcing them to invest their best efforts. Thus, agency problems tend to decrease, and productivity increases. Similarly, Schmidt (1997) claims that a high level of product market competition significantly reduces managerial slack, motivating them to dedicate much more effort to survive in a competitive market.
Early research by Alchian (1950) indicates that high product market competition encourages firms to reduce production costs to lower the cost of capital and optimize corporate governance.
Similarly, Holmstrom (1982) provides a theoretical background that increases product market competition to discipline managers to minimize costs and reduce information asymmetry and transaction costs. Numerous studies also argue that only efficient firms survive when the level of product market competition is high (Chhaochharia et al., 2017;Nickell, 1996), indicating that product market competition forces managers to work harder to improve a firm's sustainability.
Recent studies provide empirical evidence supporting the idea that product market competition encourages managers to work for shareholders' interests. Allen and Gale (2000) argued that market competition is more effective corporate governance and disciplinary mechanism than internal corporate governance or external monitoring mechanisms. Guadalupe and Perez-Gonzalez (2010) provide evidence that an increase in product market competition decreases the private benefits of managerial control, which represents the magnitude of the conflict between managers and shareholders. This result supports Fama's (1980) contention that product market competition enhances corporate governance, as an increase in competition discipline optimizes the spending and allocation of resources.
Extant research on internal and external corporate governance supports the "substitution hypothesis" that there is a substitute association between external and internal corporate governance. For instance, Giroud and Mueller (2011) provide evidence that the effects of internal corporate governance on stock returns and firm value differ, depending on the level of market competition. They show that the effect of internal corporate governance on stock returns and firm value is either small or insignificant when market competition is high, and either large or significant when competition is low.
Kim and Lu (2011) examined the relationship between CEO ownership (internal corporate governance) and product market competition (external corporate governance) to show that there is a substitution effect in reducing agency problems. Grosfeld and Tressel (2001) provide evidence that a firm's internal corporate governance determines the effect of product market competition on firm performance.
This study aims to clarify the association between product market competition and a firm's R&D investments by focusing on the external governance role of product market competition. Based on the above arguments and literature reviews, this study conjectures that product market competition, as an effective external governance mechanism, promotes a firm's R&D investments. Furthermore, this study predicts that the association between product market competition and a firm's R&D investments differs depending on the firm's internal corporate governance, considering the substitute relationship between internal and external corporate governance mechanisms. Hence, the following hypotheses are proposed: H1: Product market competition is positively associated with R&D investment.
H2: The positive association between product market competition and R&D investment is more pronounced for firms with weak internal corporate governance.

Research design
This study investigates the association between product market competition and firms' R&D investments. The study also controls for industry-and yearfixed effects and adopts the lead-lag test model by including lagged independent and control variables to address potential endogeneity issues.
The second hypothesis predicts that the positive association between product market competition and a firm's R&D investments will be stronger for firms with weak internal corporate governance mechanisms.

Sample selection
This study uses data from listed Korean companies for 2001-2020. Financial data were obtained from the TS2000 and FnGuide databases, which are equivalent to Compustat in the U.S. This study excludes firms with fiscal year-ends other than December to ensure sample homogeneity and to control for the effect of fiscal year-end. Financial firms are also excluded because they have distinct industrial characteristics and financial reporting standards. Lastly, firms without financial data were excluded, generating a large sample of 11,560 firm-year observations.  Table 2. The correlations in Table 2 show that there is no significant correlation between RD, the dependent variable, and COMP, which represents product market competition. However, drawing accurate conclusions and test results on the association between product market competition and a firm's R&D investment based on correlation coefficients is difficult. Therefore, the regression results are presented in the following tables, considering all the variables employed in the analyses. Table  2 also shows that COMP significantly correlated with PPE, SIZE, LEV, DI V, and BTM. Moreover, the correlation coefficients between the control variables were not relatively high, suggesting that multicollinearity was not a major concern in our analyses.      Table 4 reports the empirical results for the second hypothesis. The second hypothesis examines whether the effect of product market competition is stronger when a firm's internal corporate governance mechanisms are weak. To test the second hypothesis, this study divides the sample into subsamples to test the hypothesis based on board independence and foreign investor ownership.

Results
Panel A of Table 4 shows the results when the sample is divided based on the board independence.
The results indicate that the coefficient of COMP (0.7435, p-value < 0.01) is significant and positive at the 1% level for firms with weak internal corporate governance, whereas those with strong corporate governance are weak and insignificant (0.2265, p-value = 0.2873). Furthermore, the coefficient of COMP in each group was statistically different (p-value < 0.01), supporting the second hypothesis that the association between product market competition and a firm's R&D investments is stronger for firms with weak internal corporate governance.
Panel B of Table 4 reports the subsample analysis based on foreign investor ownership. The results show that the coefficient of COMP (0.8377, p-va lue < 0.01) is significantly positive for firms with foreign investor ownership lower than the industry median. However, the coefficient of COMP (-0.0801, p-value = 0.7610) for firms with higher foreign investor ownership is not statistically significant, thus supporting the second hypothesis.

Discussion
The study finds a positive association between product market competition and a firm's R&D investments, suggesting that firms are more likely to make R&D investments when product market competition is high. The result of the study implies that market competition induces firms to innovate and obtain a competitive advantage by reducing agency problems. Firms in the competitive market are more difficult to survive. Thus, managers in competitive markets are more likely to put much more effort into enhancing a firm's sustainability, which leads to an increase in R&D activities. This finding is consistent with the previous studies supporting the positive association between product market competition and a firm's R&D investments, such as Blundell et al. (1999), Nickell (1996), Geroski (1990), and Van Vo and Lee (2017), who support the idea that market competition promotes a firm's R&D investments. The result contradicts studies conducted by Blundell et al. (1995), Crepon et al. (2006), and Gu (2016), who showed a negative effect of product market competition on a firm's R&D activities.
The results for the second hypothesis show that the positive association between product market competition and a firm's R&D investments is more pronounced for firms with weak internal corporate governance. Specifically, the results show such association is stronger for firms with low board independence and low foreign investor ownership, supporting the "substitution hypothesis" that argues there is a substitute relationship between external and internal corporate governance, suggested by Giroud and Mueller (2011), Grisfekd and Tressel (2001), and Kim and Lu (2011). This result also supports the argument that product market competition significantly affects a firm's R&D investments as an effective external corporate governance mechanism.
Collectively, the results confirm that product market competition, as effective external corporate governance, disciplines managers' investment in R&D to survive. It provides evidence that there is a substitute relationship between product market competition and a firm's internal corporate governance, and the effect of product market competition is determined by the firm's internal corporate governance mechanisms.

Additional analysis
Previous studies clearly state that the effect of product market competition on a firm's R&D investment could vary depending on the firm's technological competencies and industry type (Hu et al., 2017;Lee, 2009). Therefore, this study divides the sample into two subgroups, high-tech and low-tech, to investigate whether the effect of product market competition varies depending on the industry type.
This study classifies firms into high-tech and lowtech industries using the Standard Industrial Classification (SIC) code developed by Kile and Phillips (2009). The results in Table 5 indicate that the coefficient of COMP (2.3902, p-value < 0.01) is significantly positive and significant for firms in the low-tech industry, whereas the coefficient of COMP (-0.2734, p-value = 0.5048) in the high-tech industry is not statistically significant. Furthermore, the coefficients of COMP in each group were significantly different (p < 0.01).
Previous literature shows that gains due to innovation are high, especially when the level of R&D appropriability and the firm's R&D competence is low because firms can establish a temporary monopoly through R&D activities (Lee, 2009;Tingvall & Poldahl, 2006). Thus, firms in low-tech industries are more likely to invest in R&D when the product market is competitive.

Robustness test
Following Gu (2016), this study used an alternative measure to calculate the HHI to enhance the robustness of the results. Using the same procedure, this study constructs a HHI using a firm's assets. Table 6 presents the results of the study. The coefficient of COMP_Asset (0.5790, p-value < 0.01) is positive and statistically significant, show-ing qualitatively consistent results with our main findings.

CONCLUSION
The purpose of this study is to investigate the association between product market competition and a firm's R&D investments by focusing on the external governance role of product market competition. Moreover, this study examines how internal corporate governance affects the effect of product market competition on a firm's R&D investment.
The main results of this study show that product market competition is positively associated with a firm's R&D investments, implying that market competition induces managers to invest in R&D. Moreover, the results state there is a substitute relationship between product market competition and internal corporate governance. This result supports the argument that product market competition is an effective external corporate governance mechanism that could substitute internal corporate governance. Additional analysis shows that the effect of product market competition on a firm's R&D investment varies depending on the firm's industry type by showing the stronger positive association between product market competition and a firm's R&D investment for firms in the low-tech industry.
These findings prove that product market competition is an effective corporate external governance mechanism that prevents managements' myopic behavior on a firm's R&D investments. The results also provide practical implications for investors and regulators that market policies encouraging market competition would be useful to drive firms to operate in a way to maximize a firm's long-term value by promoting a firm's R&D investments. Moreover, the result of additional analysis suggests that policymakers should consider an industry type when setting the policies regarding market structure. Collectively, the results of this study can help managers and regulators set business strategies and policies in areas related to market structure and competition.