Financial Constraints and Likelihood of Product Innovation: Firm-level Evidence from China
24 Pages Posted: 20 Apr 2020
Date Written: March 27, 2020
This paper investigates how financial constraints affect a firm’s decision on whether to conduct product innovation. Theoretically, we show that a firm's optimal decision on product innovation is a function of its past decision, financial constraints and a set of control variables. Through influencing investment, financial constraints increase a firm's marginal cost of production, which eventually reduces the firm's probability of conducting product innovation. The theoretical modelling implies a set of population moments, which we fit with firm-level data of China's manufacturing sector from 2005 to 2007. Our estimations find that the more financially constrained a firm is, the less likely it will conduct product innovation. For a firm that innovates previously, a one unit increase in financial constraints results in around 0.9 per cent drop in the probability of innovation. In contrast, it leads to around 0.14 per cent decrease in the probability if a firm does not innovate previously.
Keywords: Financial Constraints, Product Innovation, China
JEL Classification: D22, G31, L20
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