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The importance of equity finance for R&D activity

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Abstract

This article analyzes the importance of equity finance for the R&D activity of small- and medium-sized enterprises. We use information on almost 6,000 German SMEs from a company survey. Using the intensity of banking competition at the district level as an instrument to control for endogeneity, we find that a higher equity ratio is conducive to a higher R&D intensity. Owners may only start R&D activities if they have the financial resources to sustain them until successful completion. We find a larger influence of the equity ratio for young companies. Equity may be more important for young companies which have to rely on the original equity investment of their owners since they have not yet accumulated retained earnings and can rely less on bank financing.

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Notes

  1. Collateral is an important instrument used by banks. In their sample of bank loans extended by five large German banks, Elsas and Krahnen (2002) find that 71% of the loans are collateralized and 31.5% of the total credit volume is covered by collateral. Lehmann et al. (2004) report average collateral coverage of 61% for Western Germany and 53% for Eastern Germany.

  2. The number of R&D performing SMEs in Rammer et al. (2006) includes only companies with at least five employees and excludes the retail sector. The statistics of the German Private Equity and Venture Capital Association (BVK) are the most comprehensive information available. According to the BVK they cover 90% of the volume of the German VC market (Krahnen and Schmidt 2004).

  3. The R&D figures of very small companies may be less precise than the figures of large companies, since small companies often do not track R&D expenditures explicitly in their accounting system. However, this should not influence our analysis, since a systematic relationship of the imprecision with the the equity ratio is unlikely. There is no indication that small companies would inflate R&D expenditures to hide profits or would deflate sales revenue to appear smaller. Specifically, there is no R&D tax credit in Germany. All regressions contain controls for size.

  4. The second wave cannot be included for this analysis, since it contains no information about R&D.

  5. A small number of companies with negative equity were excluded from the sample. Liabilities can exceed the assets of a company, if repeated losses eat up the equity capital. The company is not closed, if creditors believe that loans can be repaid with future profits. Companies with zero equity were retained.

  6. The size difference cannot be explained with companies being larger in industries that typically perform more R&D as the difference still exists after controlling for industry effects.

  7. Petersen and Rajan (1995) develop this argument and provide empirical evidence for this effect for US banks. However, for the German capital market with a strong relationship between the company and a single bank (“Hausbankprinzip") it can be assumed that this argument is less relevant.

  8. Germany is divided into 439 districts (Kreis or kreisfreie Stadt). Berlin is the largest district with a population of 3.4 million and Zweibrücken is the smallest district with a population of 36,000.

  9. Income per capita, population figures and share of employees in the manufacturing sector are taken from Statistik regional 2004, German National Statistical Offices (Statistische Ämter des Bundes und der Länder). The categorization of districts follows INKAR 2004, Federal Office for Construction and Regional Planning (Bundesamt für Bauwesen und Raumordnung).

  10. Staiger and Stock (1997) suggest the rule of thumb that instruments are weak, if the test of excluded instruments has an F smaller than 10. The instrument financial standing passes this test, but the instrument banking competition does not pass. However, using both instruments individually we obtain similar results.

  11. The marginal effects in Tables 5–7 are calculated with the Stata procedure mfx (Stata 2007, p. 269). The equations for the marginal effects can be found in Maddala (1983, pp. 23, 160).

  12. The sample contains 1,873 companies up to the age of 10 years (32% of the total).

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Acknowledgements

We would like to thank David Audretsch, Thomas Hempell, Ulf von Kalkreuth, Tobias Klein, Georg Licht, Christian Rammer and Konrad Stahl for helpful discussions. We are grateful to Frank Reize (KfW) for making the data available. This paper was written as part of a cooperation between ZEW Mannheim and KfW Bankengruppe, Frankfurt.

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  1. Industrial Economics and International Management, Centre for European Economic Research (ZEW), 68161, Mannheim, Germany

    Elisabeth Müller

  2. Economic Research, KfW Bankengruppe, 60325, Frankfurt am Main, Germany

    Volker Zimmermann

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  1. Elisabeth Müller
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Correspondence to Elisabeth Müller.

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Müller, E., Zimmermann, V. The importance of equity finance for R&D activity. Small Bus Econ 33, 303–318 (2009). https://doi.org/10.1007/s11187-008-9098-x

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