Firm innovation in transition economies: The role of formal versus informal finance

Abstract

In this study, I investigate the association between firm innovation and formal versus informal finance for 5,982 firms in 30 transition economies. I also examine whether the association between firm innovation and formal versus informal finance differs between developed and developing countries. I find that access to formal finance is associated with greater firm innovation. I find no evidence that informal finance promotes innovation. Formal finance is more effective in fostering innovation in developing countries. By establishing a link between formal finance and innovation, I provide evidence on a potential channel through which formal finance contributes to firm growth. The findings also show the limitation of using informal finance in promoting firm innovation even for smaller firms in developing countries who substantially use financing from informal sources.