Bank Interventions and Firm Innovation: Evidence from Debt Covenant Violations
Western New England University
Connie X. Mao
Temple University - Fox School of Business and Management; Temple University - Department of Finance
Indiana University - Kelley School of Business - Department of Finance
September 15, 2014
Kelley School of Business Research Paper No. 2014-28
Fox School of Business Research Paper No. 15-041
We examine the effect of bank interventions on corporate innovation and firm value via the lens of debt covenant violations, where control rights are shifted from equity holders to creditors. Using a difference-in-differences approach and a regression discontinuity design, we find that bank interventions have a negative effect on innovation quantity but not on quality. We further show that the reduction in innovation quantity is concentrated in innovation activities that are unrelated to the violating firm’s core business, which leads to a more focused scope of innovation investment and ultimately an increase in firm value. Human capital redeployment appears a plausible underlying mechanism through which bank interventions refocus firm innovation scope and enhance firm value. Our findings are consistent with the argument that banks help mitigate investment distortions in innovation arising from conflicts of interest between managers and shareholders. Our paper sheds new light on the real effect of bank financing.
Number of Pages in PDF File: 60
Keywords: Bank interventions, innovation, covenant violations, conflicts of interest, firm value
JEL Classification: G21, G32, G34, O31
Date posted: September 22, 2013 ; Last revised: January 22, 2015
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