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«Tobias Schmidt (Deutsche Bundesbank) Wolfgang Sofka (Department of Organisation and Strategy, CentER, CIR, Tilburg University) Discussion Paper ...»

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An information economics perspective

on main bank relationships and firm R&D

Daniel Hoewer

(ZEW Mannheim)

Tobias Schmidt

(Deutsche Bundesbank)

Wolfgang Sofka

(Department of Organisation and Strategy, CentER, CIR, Tilburg University)

Discussion Paper

Series 1: Economic Studies

No 19/2011

Discussion Papers represent the authors’ personal opinions and do not necessarily reflect the views of the

Deutsche Bundesbank or its staff.

Editorial Board: Klaus Düllmann

Frank Heid Heinz Herrmann Karl-Heinz Tödter Deutsche Bundesbank, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Postfach 10 06 02, 60006 Frankfurt am Main Tel +49 69 9566-0 Telex within Germany 41227, telex from abroad 414431 Please address all orders in writing to: Deutsche Bundesbank, Press and Public Relations Division, at the above address or via fax +49 69 9566-3077 Internet http://www.bundesbank.de Reproduction permitted only if source is stated.

ISBN 978-3–86558–732–9 (Printversion) ISBN 978-3–86558–733–6 (Internetversion) Abstract Information economics has emerged as the primary theoretical lens for framing financing decisions in firm R&D investment. Successful outcomes of R&D projects are either ex-ante impossible to predict or the information is asymmetrically distributed between inventors and investors. As a result, bank lending for firm R&D has been rare. However, firms can signal the value of their R&D activities and as a result reduce the information deficits that block the availability of external funding. In this study we focus on three types of signals: Firm’s existing patent stock, the presences of a joint venture investor and whether the firm has received a government R&D subsidy. We argue theoretically that all of these signals have the potential to alter the risk assessment of the firm’s main bank. Additionally, we explore heterogeneities in these risk assessments arising from the industry level and the main bank’s portfolio. We test our theoretical predictions for a sample of more than 7,000 firm observations in Germany over a multi-year period. Our theoretical predictions are only supported for firms’ past patent activity while other signals fail to alter the risk assessment of a firm’s main bank. Besides, we confirm that the risk evaluation is not randomly distributed across bank-firm dyads but depends on industry and bank characteristics.

Keywords: innovation, banking, information asymmetry JEL-Classification: 032, D82, G30 Non technical summary The continuous generation of innovative products, processes and services is widely considered to be the primary key to firms’ competitiveness and growth. The major input in this innovation process is unique knowledge generated by investmentsin research and development (R&D). Interestingly enough, though, private firms have found it extremely difficult to obtain external capital for funding such crucial investments into their future. Banks as the main provider of external funds for the vast majority of firms seem ill-equipped to provide the necessary funding. Their shortcomings are typically explained by the nature of R&D projects, which suffer from both information imperfections and asymmetries.

We adopt a novel perspective by challenging the dominant assumption that all banks are equally subject to suffering from information asymmetries in financing private R&D. We suggest that firms can signal the value of their R&D investment and overcome the inherent information asymmetries. We focus on two mechanisms for signaling. On the one hand, firms can signal based on past innovation success. We will rely on firm’s patent stock to measure this. On the other hand, firms can signal based on relations with trusted external actors such as a joint venture investor or the government (through a subsidy). We consider all of these mechanisms and allow for heterogeneities across industries and banks in the valuation of the signals.

We test this theoretical framework empirically for more than 7,000 firm observations on R&D investments in Germany between 2002 and 2007. Unique access to the database of Germany’s leading credit rating agency on the population of German firms and their main bank relationship allows us to construct novel variables on the overall portfolio of the firm’s main bank. We have the rare opportunity to link this information to firm characteristics, R&D investment, patent statistics and venture capital investments based on a non-heuristic link.

Our empirical results indicate that banks can overcome information asymmetries in financing private R&D, by generating knowledge from their client portfolios. As far as nonfinancial firms are concerned, the results corroborate our theoretical model only for the signaling value of firm’s patent stock. Firms can shift the threshold of a bank’s risk considerations to lower levels of specialization if they can signal the value of their R&D activities through successful patent activities. On the basis of these findings, implications are derived for academic research, management and policy making.

Nicht technische Zusammenfassung Kontinuierliche Innovationsaktivitäten werden weithin als wichtige Voraussetzung für die Wettbewerbsfähigkeit und das Wachstum von Unternehmen angesehen. Der wichtigste Input in den Innovationsprozess ist spezifisches und neues Wissen, das durch Investitionen in Forschung und Entwicklung (FuE) entsteht. Allerdings ist es für private Unternehmen äußerst schwierig, sich externe Finanzierungsmöglichkeiten für diese Art von Zukunftsinvestitionen zu erschließen. Insbesondere Banken, die für die Mehrzahl der Unternehmen die bedeutendste Quelle für externe Finanzierung sind, scheinen nur bedingt in der Lage zu sein, FuE zu finanzieren. Dies wird typischerweise mit der Natur von FuE-Aktivitäten erklärt, weil dabei große Informationsasymmetrien zwischen Unternehmen und externen Investoren entstehen.





In dieser Arbeit stellen wir die allgemeine Annahme, dass alle Banken gleichermaßen von diesen Informationsasymmetrien betroffen sind, in Frage. Wir gehen davon aus, dass Unternehmen Informationsasymmetrien reduzieren können, indem sie den Wert ihrer FuE Aktivitäten den potentiellen Investoren signalisieren. Mindestens zwei unterschiedlich Signale sind denkbar: erstens, in der Vergangenheit erfolgreich abgeschlossene FuE-Projekte oder Patente und zweitens, Kooperationen und Partnerschaften mit externen Akteuren, wie z.B.

VC-Gebern oder Ministerien. Wir betrachten in dieser Arbeit beide Signale und lassen zu, dass deren Wirkung und Stärke von Bank zu Bank und Branche zu Branche unterschiedlich ist.

Wir testen unsere Hypothesen für einen Datensatz mit mehr als 7000 Unternehmen mit Sitz in Deutschland. Der Mikrodatensatz deckt die Jahre 2002 bis 2007 ab und enthält neben Daten zu allgemeinen Firmencharakteristika - sowohl Informationen zu den FuE Ausgaben der Unternehmen - als auch zur Portfoliozusammensetzung der wichtigsten Bank, mit der das Unternehmen zusammenarbeitet. Wir sind in der Lage, diese Informationen, direkt mit Daten zu Patenten, öffentlicher Förderung und Venture Capital Beteiligungen zu ergänzen.

Unsere empirischen Analysen des FuE Verhaltens zeigen, dass Banken Informationsasymmetrien gegenüber Unternehmen reduzieren können, indem Sie aus ihrem Portfolio lernen. Was nicht-finanzielle Unternehmen betrifft, bestätigen unsere Ergebnisse die Hypothesen nur bezüglich der Signalwirkung von Patenten. Die Unternehmen können die Risikoeinschätzungen der Banken positiv beeinflussen, wenn sie ihre Forschungsstärke durch Patente untermauern. Des Weiteren zeigen wir, dass die Reduktion von Informationsasymmetrien insbesondere in Sektoren auftritt, in denen große Unsicherheit hinsichtlich der Kommerzialisierbarkeit von FuE besteht.

Contents 1 Introduction

2 Theory

3 Hypotheses development

3.1 Information externalities from a firm’s main bank client portfolio

3.2 Signaling through reputation and legitimacy

4 Empirical study

4.1 Data

4.2 Empirical model

5 Results

5.1 Main bank specialization and market share

5.2 Signaling effects

5.3 Control variables

6 Consistency and sensitivity checks

7 Conclusions and future research

8 References

9 Tables

10 Appendix

List of Tables Table 1: Descriptive statistics

Table 2: Estimation results of tobit models

Table 3: Estimation results of tobit models with sub-samples of above/below average industry use of scientific knowledge

Table 4: Estimation results of tobit models including interaction effects

An Information Economics Perspective on Main Bank Relationships and Firm R&D1

1 Introduction

The continuous generation of innovative products, processes and services is widely considered to be the primary key to the competitiveness and growth of firms and of entire economies (e.g. Grant, 1996; Schumpeter, 1942). The major input of this innovation process is unique knowledge generated by investments in research and development. Interestingly enough, though, private firms have found it extremely difficult to obtain external capital for funding these crucial investments into their future. This restricts the available funds to internal cash flows and scarce, highly selective venture capital investors (e.g. Levitas & McFadyen, 2009). For example, Bureau van Dijk’s ZEPHYER database records a yearly average of only 250 venture capital investments in Germany between 1998 and 2010, the fourth largest economy in the world with a population of roughly 3.1 million firms.

This situation is paradoxical as most managers and management research acknowledges the importance of knowledge production and innovation for firm performance (e.g. Grant, 1996;

Leiponen & Helfat, 2010). Entire economies are searching for strategies for entering the knowledge-based economy and reaping the benefits in terms of investment, employment and growth. Among the most ambitious of these plans are the Barcelona and Lisbon Strategies with their aim of making the European Union the most competitive knowledge-based economy in the world. In reality, though, the knowledge-based economy finds itself without a mechanism for financing the underlying firm R&D investment. Several scholars have

Authors’ affiliations and acknowledgements:

Daniel Höwer, ZEW Centre for European Economic Research, L 7, 1, 68161 Mannheim, Germany, hoewer@zew.de, Telephone: +49 6211235187.

Tobias Schmidt, Deutsche Bundesbank, Economic Research Centre, Wilhelm-Epstein-Strasse 14, 60431 Frankfurt am Main, Germany, tobias.schmidt@bundesbank.de, Telephone: +49 6995663730.

Wolfgang Sofka, Department of Organisation and Strategy, CentER, CIR, Tilburg University, Warandelaan 2, 5000LE Tilburg, the Netherlands, W.E.J.Sofka@uvt.nl, Telephone: +31 134664051.

The authors whish to thank Heinz Herrmann, Xavier Martin, Thijs Peeters and Zilin He for their excellent feedback and comments.

highlighted the need for banks - as the main provider of external financing – to be brought back into the picture. The relevance of this topic is acknowledged in the US, for instance, by Nobel laureate Edmund Phelps (Phelps & Tilman, 2010), and in Europe (e.g. Peutz, Meeus, Nooteboom & Noorderhaven, 2010).

These shortcomings in capital markets are typically explained by the nature of R&D projects, which suffer both from information imperfections and asymmetries (for a comprehensive review see Hall, 2005). Information imperfections stem from inherent uncertainties about the technological and commercial viability of novel products for which no ex ante probabilities of success exist (Amit, Glosten & Muller, 1990). Information asymmetries arise from the fact that firms possess knowledge of the value of their R&D projects which is superior to that of external investors (Ahuja, Coff & Lee, 2005). These investors, therefore, bear the extra risk of hidden information and hidden actions.

We develop theory based on the renewed interest in financing R&D and innovation in both from strategic management (e.g. Levitas & McFadyen, 2009) and finance literature (e.g.



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