Innovation and Investment Finance in Comparison

Abstract

This article compares the financing of innovation and investment in small- and medium-sized enterprises (SME). The central finding of the study is that the financing of these two types of projects differs substantially. Innovations are for the most part covered by internal funds. Other sources of funding play a subordinate role. For investments, on the other hand, both internal funds and bank loans play an important role. The study provides evidence that points to the existence of special restrictions for the external financing of innovations. For example, the share of bank loans only increases comparatively little as innovation expenditure goes up. In addition, the share of bank loans decreases as the share of R&D expenditure on innovation spending increases. This is in line with the consideration that special features of innovation projects, such as uncertainty about the success and asymmetric information between the firm and the potential outside investor combined with a lack of new assets to collateralise bank loans, counteract external financing. Financing restrictions are likely to lead to the innovation potential lying idle due to market imperfections. Working against it thus represents a permanent task of economic policy.