Credit market disruption and corporate innovation : an empirical analysis

Abstract

This paper investigates the effects of systemic banking crises on the quantity (amount of investment) and quality (efficiency of investment) of innovation in the corporate landscape. Using the 2007-2008 financial crises as a setting for heightened credit-market friction, we find that firms reduce investment in innovation activities during periods of elevated credit-market friction. However, the decline in innovation spending is disproportionately less for high-tech firms compared to low-tech firms. We show that this is due to the R&D expenditure smoothing by technologically-intensive firms. Despite the across-the-board reduction in innovation spending, we find that indeed innovation quality improves during periods of credit-market disruption. Our results show that a tighter financial constraint induced by credit contraction significantly enhances the efficiency of innovation, particularly for technologically-intensive firms. These results suggest that credit-market conditions are important determinants in understanding the extensive (quantity) and intensive (efficiency) margins of innovation in the business sector.