The Intangible Gap

We document a large and rising intangible investment gap between small and large U.S. firms. Smaller firms invest disproportionately in intangible capital, despite facing tighter financing constraints, and this gap has tripled since the 1980s alongside a pronounced increase in intangible investment volatility. We develop a dynamic industry-equilibrium model in which firms invest in both physical and intangible capital under financial frictions. Intangible investment is subject to idiosyncratic quality shocks and can be partially financed internally through equity-based compensation. These features generate an optionlike payoff to intangible investment: downside risk is limited by exit, while upside gains scale with realized quality. This mechanism makes intangible capital particularly attractive for small firms with high exit risk. Our analysis reveals that the joint increase in intangible investment volatility and the decline in financing frictions for intangible capital account for approximately 60% of the post-2000 gap in intangible-to-physical capital ratios between small and large firms over the 2001–2023 period.