Banking Market Competition and Corporate Innovation

Abstract

By using the U.S. data, this study shows that state-level banking market competition, measured by Panzar-Rosse (1984) H-statistic, increases the number of patents and citations generated by firms and improves corporate innovation efficiency, supporting market power hypothesis. Greater banking competition is also found to enable innovative firms to adopt more ambitious innovation policies and have more flexibility to experiment with new technologies. The investigation of the heterogeneity of banking competition effects at the state-level shows that regional innovation in the states with lower R&D intensity benefits more from improved competition in local banking markets where additional innovation makes a greater marginal economic contribution. At the firm-level, such favourable effects vary across firm characteristics and innovative firms, with greater dependence on external finance and being financially constrained, enjoy a greater benefit from increased banking competition. The research also examines the role of information specialisation and finds that the banking competition effects are stronger for firms operating in informationally opaque industries and having more specialised information. It implies that banks benefit from the economies of scale in more specialised information acquisition when allocating credit supply. Finally, the research reveals novel evidence on the substitution effects of competition in a wider region and neighbour-state to local banking market in financing corporate innovations. The finding shows ‘how local is local banking market’ depends on the operating scope and information transparency of borrowing firms and local banks have an information advantage over distant banks in financing local businesses and informationally opaque corporate innovation activities.