Sovereign Risk, Credit Shocks and R&D

We study how private R&D investment in France was affected by the tightening of credit conditions during the European Sovereign Debt Crisis. Using detailed R&D information on more than 25000 French companies, we show that financially constrained firms were relatively more likely to scale back their R&D activities following the sovereign debt crisis. We then focus on bank-firm linkages and exploit variation in the sovereign risk exposure of firms’ main bank during the sovereign debt crisis as an exogenous credit supply shock. Results indicate that firms related to banks with larger exposures to risky sovereign debt decreased R&D expenditure by more relative to other firms following the crisis. Our findings indicate that credit supply shocks have significant impact on firms’ R&D activities, and highlight an important transmission channel of sovereign risk to firm innovation and productivity.