Innovation, asymmetric information and the capital structure of new firms

Abstract

ABSTRACTStart-ups are essential contributors to economic development, but they often face several barriers to growth, including access to finance. We study their capital structure in their early years of operation through the lens of Pecking Order Theory, exploring how the pursuit of innovation influences firms’ reliance on different types of finance. Panel analyses of 8273 German start-ups show that innovation activities are relevant predict start-ups’ revealed preferences for finance. Effects on the type and order of financing sources depend on the degree of information asymmetries specific to research and development activities, human capital endowments, and the market introduction of new products and processes. New firms focused on research and development activities and with better human capital are less likely to receive informationally complex finance such as debt and will rely relatively more on owner and equity finance. Mixed evidence is found, instead, on the role of new products or processes. Our results suggest that the traditional pecking order theory does not hold for new firms, implying that owner and external equity play a much more prominent role for such firms. Then, managers and entrepreneurs should consider specific sources of finance and financial instruments in light of their innovative activities.KEYWORDS: Innovationinformation asymmetriesstart-uppecking orderentrepreneurial financeJEL CODES: G32O16O30 Disclosure statementNo potential conflict of interest was reported by the author(s).Notes1 For a broader discussion on the relationship between Schumpeterian innovation and firm financial constraints see Hajivassiliou and Savignac (Citation2008), Hottenrott and Peters (Citation2012) and Lahr and Mina (Citation2021).2 Following this perspective, several contributions have explored the effect of innovation on investment selection behaviours in venture capital markets (Audretsch, Bönte, and Mahagaonkar Citation2012; Baum and Silverman Citation2004; Conti, Thursby, and Thursby Citation2013; Conti, Thursby, and Rothaermel Citation2013; Häussler, Harhoff, and Müller Citation2012; Hsu and Ziedonis Citation2013; Mann and Sager Citation2007; Lahr and Mina Citation2016).3 Before 2014 this database was known as KfW/ZEW Start-up Panel.4 The first two years of data (i.e., 2005-2006) only contain information about the firm’s cost, investments and revenues and exclude information on innovation. Therefore, they cannot serve the purpose of this study.5 We stress that our data indicate the types of financing obtained by firms, but contain no information on whether firms have applied for other types of finance and were rejected. In other words, without observation of finance-seeking behaviours, we can only observe the “revealed preferences” of firms.6 The results of simple Logit models are available upon request. All the statistical tests confirmed the better fit of all panel specifications.