Digital transformation, total factor productivity, and firm innovation investment

In the context of the digital economy, empowering firm innovation investment through digital transformation is an important strategy for promoting innovation development in China. This study investigates the effects and mechanisms of digital transformation on firm innovation investment from the perspective of total factor productivity, using a sample of manufacturing companies listed on the A-share market in China from 2012 to 2021. The following three main findings were obtained. First, results of both fixed- and random-effects regression methods revealed that digital transformation significantly promotes firms' innovation investment. This conclusion remains robust after controlling for endogeneity issues using the instrumental variable method and replacing the explanatory variable measurement methods. Second, stepwise regression analysis revealed a negative mediating mechanism of total factor productivity (TFP) in the impact of digital transformation on the level of firm innovation investment. The main reason for this is that an improvement in TFP intensifies the competition for capital and labor input between the production and innovation departments. Third, the group regression for heterogeneity analysis found that the overall effect of digital transformation on firm innovation investment is significantly positive in groups with low financing constraints and high human capital, but not significant in groups with high financing constraints and low human capital. Moreover, the negative mediating mechanism of TFP is significantly valid in all groups, further validating the competition between the production and innovation departments for capital and labor input. Based on the findings of this study and from the perspective of governance by the Chinese government, three policy recommendations are proposed to empower firm innovation development through digital transformation.