Real Effects of Bank Governance: Bank Ownership and Corporate Innovation

In this paper we analyze the impact of government and private ownership of banks on firms’ probability to innovate. We estimate firms’ decision to innovate and their selection of a main lender for a sample of 9000 German manufacturing companies. Since these two decisions may be simultaneously made we use the number of private and government bank branches located in close proximity to our sample firms as an instrument for the selection of each firm’s main lender. We find that the probability of a firm to innovate is about 10 to 13 percent higher if the main lender is a private compared to a government bank (after controlling for firm characteristics and selectivity bias). The ownership type of the main lender is especially important for small firms since their access to finance is more dependent on the local supply of lenders. Therefore, extensive government involvement in the allocation of credit comes at the cost of lower corporate innovation and economic growth.