Bank Interventions and Firm Innovation: Evidence from Debt Covenant Violations

Abstract

We examine the effect of bank interventions on corporate innovation and firm value via the lens of debt covenant violations. Bank interventions have a significantly negative effect on innovation quantity, but no significant effect on quality. The reduction in innovation quantity is concentrated in innovation activities that are unrelated to the violating firm’s core business, leading 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 innovation scope and enhance firm value. Our paper sheds new light on the real effect of bank financing.

Keywords: Bank interventions, innovation, covenant violations, human capital redeployment, firm value

JEL Classification: G21, G32, G34, O31