Financing Constraints and a Firm's Decision and Ability to Innovate:Establishing Direct and Reverse Effects

The paper analyzes the existence and impact of …financing constraints as a possiblyserious obstacle to innovation by …firms. Direct measures of fi…nancing constraints areemployed using survey data collected by the Banque de France and Eurostat, whichovercomes the problems with the traditional approach of trying to deduce indirectlythe existence and impact of …financing constraints through the signi…ficance of …rmwealth variables. The importance of using direct as opposed to indirect measuresof …financing constraints has been illustrated recently by two articles in this Journal(Moyen (2004) using a synthetic sample methodology, and Hennessy and Whited(2007) through the method of simulated moments). The econometric framework weemploy in our study is the simultaneous bivariate probit with mutual endogeneityof direct indicators of …financial constraints and innovation decisions by …firms. Thepaper discusses the important issue of coherency conditions in such LDV models.Our novel estimation methods allow us for the fi…rst time to quantify the interactionbetween …financing constraints and a …firm's decision and ability to innovate withoutforcing the econometric models to be recursive. Hence, we obtain direct as well asreverse interaction effects, leading us to conclude that binding …financing constraintsdiscourage innovation and at the same time innovative …firms are more likely to facebinding …financing constraints. Finally, we establish a strong role for state-dependencein dynamic versions of our models.[...]