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Innovation under financial restrictions

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  • Neff, Cornelia

Abstract

How do financial constraints influence innovative activities of firms? In a two-period model of price competition with differentiated products we first analyze the incentives to innovate when both firms are self-financed. We then assume that one of the firms is financially constrained and therefore has to apply for a bank loan. If Information is asymmetrically distributed between the bank and the firm, the optimal, incentive-compatible debt contract will lead to a reduction of the innovative efforts of the financially restricted firm. On the other side, the unleveraged rival will increase her innovative activities and might even become a monopolist in the second period of competition. If we finally assume that both firms are financially constrained and apply for a loan at their house bank, we can show that Innovation activities are further reduced and overall welfare will decline.

Suggested Citation

  • Neff, Cornelia, 1998. "Innovation under financial restrictions," Tübinger Diskussionsbeiträge 129, University of Tübingen, School of Business and Economics.
    • Handle: RePEc:zbw:tuedps:129
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    References listed on IDEAS

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    More about this item

    Keywords

    competition; Innovation; financial contract; asymmetric Information;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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