Finance and Innovation: The Case of Publicly Traded Firms
University of Nebraska
Vikram K. Nanda
University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics
University of Chicago - Booth School of Business
May 1, 2007
Ross School of Business Paper No. 970
AFA 2007 Chicago Meetings Paper
EFA 2006 Zurich Meetings Paper
We hypothesize that public firms that create novel innovations rely more on arm's length financing (equity and public debt) than on relationship based bank financing. A primary reason is that banks, unable to evaluate novel technologies, will tend to discourage investing in innovative projects and be more prone to shut down ones that are ongoing. Using a large panel of US companies from 1974-2000, we find that consistent with our predictions, firms that rely more on arm's length financing have a larger number of patents and these patents are more significant in terms of influencing subsequent patents. We confirm our findings by showing a significant increase in innovative activity of firms following a large infusion of arm's length financing and no such pattern after a similar infusion of bank loans. Creating novel innovations leads to a significantly higher firm value and suggests that firms would rationally take into account the potential impact of innovative activity when making their financing choices. Finally, we use an IV approach to ameliorate endogeneity concerns and demonstrate that our findings are driven primarily by innovative firms choosing their financing arrangements.
Number of Pages in PDF File: 50
Keywords: Technological, Innovation, Finance, Growth, Patent, Citations, Arm's Length, Capital Structure
JEL Classification: G30, O33
Date posted: June 9, 2005 ; Last revised: October 9, 2014
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