Do Financial Constraints Reduce Process Innovation? Evidence from Australian Firms

Abstract

Accessing external finance for innovation is notoriously difficult. We study the effect of financial constraints on the probability of conducting process innovation, while also considering the role of past innovating experience. Theoretically, we show a firm’s optimal process innovation decision is a function of its previous decision, financial constraints, and a set of control variables. This decision naturally leads to a set of population moments, which we then test empirically using Australian microdata from 2006-2018. Our results reveal that if a firm does not conduct process innovation in the previous year, financial constraints reduce the probability of process innovation by around 10%. Whereas if a firm does conduct process innovation in the previous period, financial constraints reduce the probability of process innovation by around 12%.