Financing Constraints, Firm Dynamics and Innovation
AbstractThis paper develops the model of an industry with heterogeneous firms, and studies the effect of financing frictions and bankruptcy risk on innovation and aggregate productivity growth. The model has two main features: i) the technology of firms gradually becomes obsolete. Firms can counter this process by innovating, but the innovation outcome is risky. ii) Financial frictions cause the inefficient default of financially fragile firms, deter entry, and reduce competitive forces in the industry. I calibrate and solve the model and simulate several industries, and show that financing frictions have two distinct effects on innovation: a "direct effect", for firms that cannot innovate because of lack internal funds to invest, and an "indirect effect", where the changes in competition and profitability change also the incentives to innovate. Simulation results first show that, for realistic parameter values, the indirect effect of financing frictions is much more important than the direct effect in determining the innovation decisions. Second, they show that "Safe innovation" (where firms invest to upgrade their technology and are certain to increase their productivity) is increased by the presence of financing frictions, because the reduction in competition increases the return on innovation. Conversely "Risky innovation" (where firms invest to improve their productivity, but with some probability fail to do so and end up reducing their productivity instead), is discouraged by financing frictions. This happens because the reduction in competition implies that firms remain profitable for a longer time and therefore they wait longer before attempting a risky innovation process. I test these predictions and their implications for productivity growth on a sample of Italian manufacturing firms, and I find that the life cycle and innovation decisions of firms are fully consistent with the model with risky innovation.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 300.
Date of creation: 2013
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-05 (All new papers)
- NEP-BEC-2013-10-05 (Business Economics)
- NEP-COM-2013-10-05 (Industrial Competition)
- NEP-DGE-2013-10-05 (Dynamic General Equilibrium)
- NEP-ENT-2013-10-05 (Entrepreneurship)
- NEP-INO-2013-10-05 (Innovation)
- NEP-KNM-2013-10-05 (Knowledge Management & Knowledge Economy)
- NEP-SBM-2013-10-05 (Small Business Management)
- NEP-TID-2013-10-05 (Technology & Industrial Dynamics)
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- Andrea Caggese, 2004.
"Testing financial constraints on firm investment using variable capital,"
Money Macro and Finance (MMF) Research Group Conference 2003
9, Money Macro and Finance Research Group.
- Caggese, Andrea, 2007. "Testing financing constraints on firm investment using variable capital," Journal of Financial Economics, Elsevier, vol. 86(3), pages 683-723, December.
- Andrea Caggese, 2003. "Testing Financing Constraints on Firm Investment Using Variable Capital," Working Papers 65, Barcelona Graduate School of Economics.
- Andrea Caggese, 2003. "Testing financing constraints on firm investment using variable capital," Economics Working Papers 1009, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2006.
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