Informed Finance and Technological Change: Evidence from Credit Relationships

Abstract

This paper empirically investigates the effect of “informed finance” on technological change. We argue that the theoretical literature offers conflicting predictions on whether the information of financiers fosters or impedes firms’ innovation. Using data from a sample of Italian manufacturing firms, we find that the information of firms’ main banks, proxied by the duration of credit relationships, fosters innovation. We also find some evidence that this positive effect is economically and statistically more significant for product than for process innovations. The latter result may signal that the alleged tight secrecy of process innovations exacerbates the negative effects of bank’ information on innovation. JEL Codes: G21, O30. In the last two decades, a large body of theoretical literature has analyzed the role of financial institutions and markets in mitigating informational asymmetries between savers and firms, and the resulting allocative inefficiencies (see Allen and Gale, 2000, and Gorton and Winton, 2003, for detailed surveys). While this literature initially concentrated on technologically static environments, several papers have recently investigated the benefits of “informed finance”1 for technological progress (see Levine, forthcoming, for a detailed survey). Some studies (e.g. De la Fuente and Marin, 1996) show that informed financiers can deter entrepreneurs’ moral hazard in the development of new products. Other studies (e.g. King and Levine, 1993) show that informed financiers can better evaluate entrepreneurs and reveal the expected profits from introducing new production techniques. The theoretical literature is however far from being conclusive on whether the information of financiers fosters or impedes technological progress. Some scholars (e.g. Rajan, 1992; Diamond and Rajan, 2001; Ueda, 2004; Landier, 2003) highlight the power that is attached to the information of financiers when contracts are imperfectly enforceable. These scholars find that informed lenders can exploit the limited possibility of informationally opaque firms to address alternative financiers and, by threatening to withhold their financial services (hold-up), extract surplus. Since innovative firms are likely to be more informationally opaque than non-innovative ones and, hence, more exposed to the hold-up of their financiers (Rajan and Zingales, 2001), this can bias firms against innovation. Other scholars (e.g. Bhattacharya and Ritter, 1983; Bhattacharya and Chiesa, 1995; Yosha, 1995) show that informed financiers may disclose confidential information to firms’ competitors. In turn, this leakage of information can erode the returns that firms expect from innovation. In the light of the conflicting predictions of the theoretical literature, whether the information of financiers exerts a positive or a negative effect on technological progress is ultimately an empirical 1 In the literature, the concept of “informed finance” has different, sometimes overlapping, interpretations. For example, some studies stress that relationship financiers have higher ability to produce information than transactional ones. Other studies focus instead on intermediaries’ higher ability to produce information relative to dispersed financiers. question. To the best of our knowledge, this question has not been empirically tested. As Levine (forthcoming) stresses, existing studies explore the broad nexus between finance and growth or, sometimes, the nexus between finance and innovation. However, probably because of the dearth of data, these studies do not test whether the nexus between finance and innovation stems, say, from the role of financiers in generating information, in creating liquidity or in allowing efficient risk-sharing. Clearly, understanding whether an “informational link” exists between finance and firms’ innovation and, if so, in what direction it works, is crucial not only to solve the theoretical uncertainty, but also to form financial policies that promote technological progress. The objective of this paper is to empirically test the effect of the information of financiers on firms’ innovation. In our analysis, we focus on banks. Banks appear a suitable object of analysis for at least two reasons. First, banks are generally believed to be efficient information producers. A vast literature argues that features of banks such as their concentrated nature and their emphasis on relationship lending foster their incentives and ability to collect information on borrowers (see Gorton and Winton, 2003, for a review of this literature).2 This view is well summarized by Levine (forthcoming) who writes that “proponents of bank-based systems argue that there are fundamental reasons for believing that market-based systems will not do a good job of acquiring information about firms [...]. Banks do not suffer from the same fundamental shortcomings as markets. Thus, they will do a correspondingly better job at researching firms.” Second, from a methodological perspective, there appears to be a consensus on proxies for banks’ information. A recent literature on relationship lending (see, for instance, Petersen and Rajan, 1994 and 1995; Berger and Udell, 1995; Degryse and van Cayseele, 2000; Ongena and Smith, 2001) provides evidence that variables such as the length of the relationship between the bank and the borrower and the scope of financial services provided by the bank constitute good proxies for information. In particular, according to Berger and Udell (2002, p. 32), by now there exists substantial Diamond (1984) provides a theoretical model on financial intermediaries as delegated monitors.

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@inproceedings{Herrera2004InformedFA, title={Informed Finance and Technological Change: Evidence from Credit Relationships}, author={Ana Maria Mantilla Herrera and Raoul Minetti and Luigi Guiso and S. Haider and Steven Ongena and Rowena A. Pecchenino}, year={2004} }