Access to external financing is of high importance to companies for the financing of fixed investments. Investment in fixed assets occurs in irregular intervals and requires relatively large amounts of financing, whereas internal financing from cash flow accrues more continuously. For large investment projects internal financing is therefore unlikely to be sufficient. Bank financing is especially important for small and medium-sized enterprises (SMEs), because they have no access to either the public equity market or to the corporate bond market. When companies apply for loans they are not sure whether they will actually receive financing. So far, little is known about how companies adjust their investment volume in case desired loans turn out to be unavailable. It is also not known which financing mix companies choose for the investment they are able to realize. Our main focus is on differences between innovative and non-innovative companies. Whereas debt financing is less well suited for innovative companies due to the higher uncertainty regarding their returns, equity financing has the advantage of the financier participating in the upside potential of the company. Innovative companies may be better able to cope with loan denials if they are able to substitute external equity for unavailable bank loans. The analysis is based on an annual company survey conducted by KfW Bankengruppe that is representative of German SMEs. We build on more than 4,500 observations relating to the years 2005 to 2007. The survey is unique in that it provides detailed information on planned investment, actual investment, experience with loan applications and innovative activities. Econometrically we control for the non-randomness of loan denials by estimating a selection equation for loan denials. We use the intensity of banking competition at the district level as an exclusion restriction to ensure identification is not only based on functional form assumptions. We find that innovative companies can better cope with loan denials. Compared with noninnovators, innovators can realize additional 10.0 percentage points of the share of actual to planned investment when facing a loan denial. By investigating the mix of financing sources that companies ultimately use to finance their actual investment, we provide an explanation for the better performance. Innovative companies that experience a loan denial have the ability to increase the share of external equity in their financing mix. Facing a loan denial, innovators finance 6.7% of their investment with external equity compared with only 1.1% for non-innovators. External equity includes business angel financing, venture capital, and equity investment of new owners. Innovative companies may be turned down by banks because debt is not the optimal type of financing for them. If their investment projects are profitable, however, they may be able to attract equity investors.

Müller, Elisabeth and Frank Reize (2010), Loan Availability and Investment – Can Innovative Companies Better Cope with Loan Denials?, ZEW Discussion Paper No. 10-025, Mannheim, published in: Applied Economics. Download


Müller, Elisabeth
Reize, Frank


Investment, loan availability, innovation, private equity