Bank Interventions and Firm Innovation: Evidence from Debt Covenant Violations

60 Pages Posted: 22 Sep 2013 Last revised: 22 Jan 2015

Yuqi Gu

Western New England University

Connie X. Mao

Temple University - Fox School of Business and Management; Temple University - Department of Finance

Xuan Tian

Tsinghua University - PBC School of Finance

Date Written: September 15, 2014

Abstract

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.

Keywords: Bank interventions, innovation, covenant violations, conflicts of interest, firm value

JEL Classification: G21, G32, G34, O31

Suggested Citation

Gu, Yuqi and Mao, Connie X. and Tian, Xuan, Bank Interventions and Firm Innovation: Evidence from Debt Covenant Violations (September 15, 2014). Kelley School of Business Research Paper No. 2014-28; Fox School of Business Research Paper No. 15-041. Available at SSRN: https://ssrn.com/abstract=2329007 or http://dx.doi.org/10.2139/ssrn.2329007

Yuqi Gu (Contact Author)

Western New England University ( email )

1215 Wilbraham Rd
Springfield, CT 01119
United States
413-796-2755 (Phone)

Connie X. Mao

Temple University - Fox School of Business and Management ( email )

416 Alter Hall
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Xuan Tian

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing 100083
China
+86-10-62794103 (Phone)

HOME PAGE: http://xuantian.info/

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