Abstract
Corporate investment in R&D is a critical ingredient to innovation and economic growth. Using a regression discontinuity design, we show that corporate investment in R&D declines sharply following a financial covenant violation. The reduction in R&D is more severe in firms with low R&D efficiency i.e., when R&D is less productive in terms of ROA and innovative output. Hence, a reduction in R&D does not result in a drop in innovative output. These results highlight that lenders are judicious in exercising their control rights and suggest that bank financing can be a viable source of financing for innovative firms.
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