Financial systems and innovation: Evidence from banking deregulations

We present evidence consistent with the Schumpeterian view that financial systems play a key role in fostering innovation. Our empirical approach exploits the wave of banking deregulations passed in the U.S. during the 1980s and early 1990s to estimate the effect of an exogenous increase in both credit availability and quality of intermediation on corporate innovation. Our findings indicate that the deregulations of the banking sector lead firms to innovate more. The effect is particularly pronounced for small firms, financially-constrained firms, firms operating in skill-intensive industries and competitive industries. We also find that the positive effect of banking deregulations on innovation does not depend upon the quality of corporate governance, measured by exploiting the passage of Business Combination (BC) laws in 30 U.S. states during the latter half of the 1980s.