Debt, Innovation, and Growth
69 Pages Posted: 13 Jul 2019 Last revised: 4 Aug 2020
Date Written: July 30, 2020
Recent empirical studies show that innovative firms heavily rely on debt financing. Debt overhang implies that debt hampers investment by incumbents. We show that a second effect of debt is that it stimulates entry of new firms and, therefore, innovation. Using a Schumpeterian growth model in which firms' dynamic R&D and financing choices are endogenously determined, we demonstrate that this second effect always dominates, so that debt fosters innovation and growth at the aggregate level. Our paper shows that debt financing has large effects on firm turnover and industry structure. It also predicts substantial intra-industry variation in leverage and innovation.
Keywords: debt, innovation, industry dynamics, growth
JEL Classification: G32, O30
Suggested Citation: Suggested Citation