Does a Financial Crisis Impair Corporate Innovation?

We examine whether a financial crisis impairs corporate innovation in the context of the 1997- 1998 crisis in Japan which features a sharp decline in bank credit, the collapse of multiple major banks, and the economy’s failure to revert back the pre-crisis growth trend. In order to explore causal mechanisms, we link together three separate pieces of firm-level longitudinal data sets: (1) patent counts from 1994-2003 as well as the number of future patent citations up until 2018 to measure the quantity and quality of innovation output, (2) dependence on intermediated funds, (3) financing relationships with the failed banks. We show that innovative outputs of firms that rely more heavily on bank finance fell more, and that bank dependence matters more for small firms. In addition, as compared to otherwise similar firms, a group of small firms which had long-term relationships with the failed banks exhibited a large, persistent decline in innovative outputs. Taken together, the results are consistent with the view that crisis-induced disruptions in the provision of intermediated funds have long-term effects on innovative capacity of the opaque, bank dependent firms.