Link between innovation support and low productivity

The following text was also published in Entré No 2, 2018:

Medium-sized enterprises have the hardest time finding financing for innovation. At the same time, the demand for finance depends on the innovation capacity of firms. Thus, it may be that medium-sized enterprises have the most difficulty finding finance because they have the greatest need.

Linda Dastory has presented her licentiate thesis Financing of Innovation in SMEs at KTH. She has examined the relative opportunities for firms to finance innovation depending on the size of the firm. Dastory has also studied whether the possibility of financing small and medium-sized enterprises with bank loans has deteriorated with the stricter banking regulations, such as Basel III.

It turns out that banking regulation has not affected firms’ ability to finance either innovation or physical investment. Nor has it had a significant impact on firms’ productivity. However, the mix of different forms of financing has changed. Firms are less likely to use venture capital, equity or mezzanine finance – a form of ‘top-up’ lending, often at high interest rates – in favor of various forms of public subsidies.

At the same time, the study shows that firms that finance innovation with grants or mezzanine loans have significantly lower productivity after one year. This may indicate that firms with low productivity are more likely to receive grants. On the other hand, mezzanine loans can be a costly source of finance and therefore limit firms’ ability to grow in the long term. However, whether the cost of capital is a mechanism explaining the negative influence remains to be investigated, according to Linda Dastory.

Her research is based on data from the German Community Innovation Survey and the Mannheim Innovation Panel.

Contact linda.dastory@indek.kth.se