Abstract
Innovation sustainability requires sustainable financing. Extensive research suggests that debt is a disfavored source of innovation financing. In this study, we show that a recent financial development, credit default swaps (CDSs), may change the institutional logics of debt, making debt useful to the financing innovation. To be specific, we find that with CDS protection, creditors become less concerned with a borrowing firm’s credit risk and risk taking, making debt tolerant of early failures and reducing the negative impact of debt on the process of Innovation. In addition, we find that the availability of CDSs is more likely to change the nature of long-term debt than that of short-term debt, making long-term debt a useful instrument for the financing of innovation. Finally, the mitigation effect of CDS on the relation between debt and innovation is more pronounced for CDS firms with higher pay sensitivity to stock price volatility (Vega) and less financial constraints, revealing that a CEO’s incentive, rather than the relaxed financing constraints, is the underlying channel for the reduced negative impact of debt on innovation after CDS trading.
Highlights
Sustainable growth in firms’ profits depends on a lot of factors, of which business conceptions and innovation are of great significance [1,2,3]
We examine the effect of the onset of credit default swaps (CDSs) trading on the relation between debt and innovation
We investigate the differential impact of CDS trading on the relation between long-term, short-term debt, and innovation
Summary
Sustainable growth in firms’ profits depends on a lot of factors, of which business conceptions and innovation are of great significance [1,2,3]. In reality, innovative firms face serious financing frictions, which lead to credit rationing, increased cost of capital, and a suboptimal level of innovation investment. How to help innovative firms mitigate their financing frictions has become an important question for the sustainability of a society, and has received much attention from academic researchers [5]. We study whether and how a financial instrument innovation, credit default swaps (CDSs), helps firms to use debt as a financing source of sustainable innovation investments. Extensive research has suggested that innovation investments have certain characteristics, such as uncertain payoffs and limited collateral value that make debt a poor financing instrument for innovation [5,6,7]. Gaining access to sustainable debt financing still remains important for all innovative firms
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