The Small, the Young and the Innovative: A Panel Data Analysis of Constraints on External Innovation Financing

The access to external finance often represents a critical factor determining a firm’s ability to survive, grow and engage in innovative activities. This study attempts to enrich existing research by investigating the effects of the recent financial crisis as well as the characteristics of firms on the access to external finance.
Whereas most previous literature has used ad-hoc, cross-sectional survey data or rough innovation indicators like R&D-expenditures, we use a longitudinal data set that spans annual surveys over a 13 year period covering 1397 unique firms and has consistent questioning and methodology. The data are collected in a region of Denmark.
We test in a probit model hypotheses derived from the literature that point to that characteristics of firms such as their age, size, innovativeness may impact both their demand and their likelihood of being financially constrained.
Overall we do confirm that such characteristics matter to demand and constraints, however, there are also indications in the results that modify and reject such a priori assumptions. We find that while incremental innovation is usually rewarded by financers, the results for more radical or technology based innovations are more ambiguous. We attribute these findings to the fact that financiers apparently are able to cope with asymmetries of information and other reasons for credit rationing in a small, dense region where innovation activities are primarily incremental and non-science based.
In brief, static, non-innovative firms are in our analyses financially constrained; firms with some innovation are rewarded, and technology-based, high-tech innovation firms are often constrained. This complies with earlier studies that posit that ‘some, not too much, innovation is good’ (Freel, 2010). On a micro level of aggregation implications for management is that raising finance for radical innovation may require substantial own funds for collateral.
On a higher level of aggregation a complementary interpretation of our results is that capital markets work differently in small, dense environments because information flows more easily and networks between firms and between financiers facilitate both mitigating information asymmetries and the insourcing of knowledge (Stuart and Sorenson, 2001).
The study is valuable in pointing out that the access to finance discussion needs to be nuanced as our analyses shows that the ‘financial gap’ is not one big hole for all firms, rather looks different for different firms.