The Interdependence of Debt and Innovation Sustainability: Evidence from the Onset of Credit Default Swaps

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.

The impact of corporate social responsibility on innovation in small and medium‐sized enterprises: The mediating role of debt terms and human capital

“…Debt, then, becomes a stimulus to investment (Choi et al, 2016; García‐Pérez et al, 2013; Wu et al, 2016). In addition, when debt costs are lower, companies have greater possibilities to innovate (Chen & Zhang, 2019). The influence of debt terms is greater for more innovative companies (Sun, 2020), which is accentuated even further in SMEs (Gorodnichenko & Schnitzer, 2013).…”

“…The better the debt terms are, the greater a firm's capacity to innovate will be (Wu et al, 2016). In addition, due to its risk and cost (Chen & Zhang, 2019; Rangel, 2012), debt becomes an essential instrument to steer innovation to its optimum level (Choi et al, 2016). Investment in innovation represents a bet on the future, which can generate uncertainty (Ayalew & Xianzhi, 2019).…”

Evaluating the role of banking efficiency, institutions and financial development for sustainable development: Implications for Belt and Road Initiative (BRI)

“…Similarly, by applying OLS methods, Breuer [ 28 ] concluded that there is a positive association between capital allocations and the legal protection of minority investors. Using a panel approach, Chen et al [ 29 ] highlighted the significance of institutions for credit cycles. They learned that improvements in operative creditor rights led to a decrease in the volatility of the credit cycle.…”