Bank Geographic Diversification and Corporate Innovation: Evidence from the Lending Channel

Abstract

By integrating the staggered interstate bank deregulation into a gravity model following Goetz, Laeven, and Levine (2013, 2016), we construct a time-varying bank-specific instrument for geographic diversification and investigate its causal effect on corporate innovation via the lending channel. We find that bank geographic diversification spurs corporate innovation, and enhances the economic value of innovation. We identify relaxing debt covenants and alleviating borrowers’ financial constraints as the two underlying mechanisms for the documented effects. Moreover, via offering lenient covenants, geographically diversified banks provide greater financial and operational flexibility to borrowing firms, facilitating them to engage in future mergers and acquisitions.