Credit Crunch Slows Down Investment by Innovative Firms
ResearchResearch and Development
Internal financing constraints in firms impair their own research and development (R&D) investments, especially when these firms are facing restrictions on borrowing. The balance sheet of a firm’s main bank also plays a decisive role in how much internal financing bottlenecks influence the investments a firm makes in R&D. Investments by firms with a lower credit rating drop particularly sharply if the main bank is beleaguered. These are the results of a study conducted by ZEW Mannheim in cooperation with TU Dortmund University.
The study examines how financing constraints before, during, and after the financial crisis of 2008/09 affected the investments of firms and their R&D activities, with researchers also looking into what role the balance sheet of a company’s main bank has in all of this. Data basis is the Mannheim Innovation Panel (MIP), ZEW’s annual innovation survey, which has been conducted since 1993. The MIP comprises information on more than 20,000 firms, including the principal bank of each individual firm. The authors of the study also use bank balance-sheet data from the Bankscope database, as well as a credit rating index from Creditreform. A firm’s credit rating serves as a measure of internal financing constraints.
The study shows that firms that had low credit ratings and therefore faced financing constraints made bigger cuts to their R&D investments during the financial crisis of 2008/09 than other firms. “In the event of negative economic shocks, firms experience difficulties in accessing financing sources for R&D,” explains Professor Kornelius Kraft, ZEW Research Associate and professor of economic policy at TU Dortmund University, who co-authored the study with Dr. Marek Giebel from TU Dortmund University. “As a result, they are forced to increase borrowing from banks, which drives up financing costs and decreases R&D investment.”
Bank distress affects corporate clients
Furthermore, the researchers investigated how the situation of a firm’s main bank affected corporate R&D investments during the financial crisis. If the main bank of a firm had sufficient capital funds before the crisis, the firm was less likely to reduce R&D investments during and immediately after the crisis. Firms that faced financing constraints, on the other hand, significantly reduced R&D spending between 2007 and 2009, if their main banks fell into financial distress.
According to the authors of the study, this effect is a result of the financial crisis. In 2007, the Basel II Accord came into force, which imposed more stringent capital requirements on banks, especially with regard to the credit ratings of borrowers. The aim was to make it more difficult for firms with poor credit ratings to obtain loans for R&D investments, regardless of the bank’s level of capital reserves.
Overall, the study shows that firms that face financing constraints due to low credit ratings are likely to reduce R&D investments, if they have only limited access to external financing sources. “It may therefore be necessary to provide subsidies for innovative firms in times of financial crises,” concludes Kornelius Kraft. “R&D plays a major role for economic growth and technological progress. Especially in times of crisis, innovative firms may find it harder to obtain financing though banks, as the lack of internal resources has a greater impact on credit assessments. We also observed that distressed banks often pass on their own capital constraints to corporate clients, sending them into a credit crunch.”