Capital Structure and Innovation:

Causality and Determinants

Eleonora Bartoloni

Warwick Business School CV4 7AL Coventry, UK and ISTAT, National Institute of
Statistics, Via Porlezza 12, 20123 Milano, Italy. E-mail: bartolon@istat.it.

Abstract
It is widely recognized that a rms nancial behaviour is the result of
a complex mix of conditions, both internal and external to the rm;
these may aect its investment decisions and its growth opportunities. This paper oers a twofold contribution to the empirical debate
on the nancing of innovation. First of all, it provides a comprehensive descriptions of possible simultaneous patterns which may aect a
rms relevant dimensions, namely innovation inputs, innovation output, leverage and protability. By using a Granger-Causality framework we will show that a rms leverage does not cause innovation output, as proxied by a measure of a rms successful innovation, while it
is rather caused by successful innovation and a rms operating profitability. The second contribution is an original investigation of the
determinants of a rms capital structure based on a panel of Italian
rms which links the third Community Innovation Survey with an administrative data source providing economic and nancial information
collected from balance sheets and income statements referring to the
period 1996-2003. This paper provides support for the pecking order theory as our rms are less indebted when operating protability
increases, but the use of external funding increases with their innovative eort. We also nd support for the existence of credit constrains
which seem to aect small innovative rms when compared with larger
enterprises.

JEL Classications: G32, O32, L25

Keywords: Capital Structure Innovation Protability Community Innovation Survey Panel data

Introduction

The nancing of an innovative project may take years before producing economic returns, and a rm wanting to exploit increased opportunities
through innovation may not have the internal resources needed to cover the
entire cost of such an investment. However, in an imperfect world dominated by asymmetric information, bankruptcy risks and agency conicts,
external nancing may be highly costly; thus, a rms investment behaviour
might be constrained in terms of the availability and cost of nance. This
is theoretically explained by considering the high risk inherent in complex
innovative projects which may exacerbate informational frictions between
insiders (managers or entrepreneurs) and outsiders (investors). Within this
framework, a consistent part of the literature has investigated the relationships between nancial factors and a rms investment decisions (Fazzari,
Hubbard and Petersen, 1988; Hubbard, 1998). It has been argued that nancial constraints should aect R&D investments more severely because of
the high degree of uncertainty characterizing innovation output. There is
also evidence that such constraints may have dierent impacts depending
on rm-specic characteristics such as size and age, or institutional factors
(Hall, 2002).
Much of the empirical work on the relationship between a rms nancing
and innovation is based on the traditional framework developed in order to
analyze capital investment decisions, and thus assumes that the direction of
causality runs from nance to innovation. This interpretation might also be
reinforced by the generally recognized strategic relevance of forms of seed
funding, such as venture capital, in stimulating technological progress.
However, there is room to believe that the opposite may be the case,
given that when innovative projects are able to open up opportunities, there
could be a demand for specic nancial instruments which then aect a
rms capital structure. The possible implications of this opposite interpretation could be of great interest when empirical investigations specically
focus on the role of equity nancing, in particular venture capital.
Support for the reverse causation hypothesis, i.e. that innovation Granger
causes nancial decisions, has been found at both country and sectoral levels
(Ueda and Hirukawa, 2003; Geronikolaou and Papachristou, 2008). However, further investigation is fundamental, in order to better clarify the inner nature of the relationship between nancing choice and innovation. In
particular, rm-level investigation and the use of dierent proxies for both
nancial behaviour and innovation may provide a clearer-cut picture of the
possible causality.
3

Empirical evidence for the determinants of capital structure is extensive

(see Harris and Raviv, 1991, for a comprehensive review). One important
implication from this strand of empirical literature is the argument in favour
of the pecking order hierarchy of nancing sources proposed by Myers and
Majluf (1984). The pecking order theory of capital structure suggests that
rms preferred option for nancing new investments is internal resources,
provided that an adequate ow of retained earnings is available. When the
amount of internally-generated funds is not sucient and external resources
are required, rms prefer debt nancing, which is less costly; equity will only
be used as a last resort.
The role of rm- and industry-specic characteristics in determining a
rms leverage has been much investigated (Bradley et al., 1984; Titman and
Wessel, 1988), whereas there is relatively little empirical evidence regarding
the role of a rms innovative behaviour. The empirical models developed
within this analytical framework predict that leverage decreases with profitability (Hovakimian et al., 2001; Aghion et al., 2004; Heyman et al., 2008;
Magri, 2009) and with alternative forms of internal resources (Colombo and
Grilli, 2007). However, the eect of innovation remains ambiguous.
In a world dominated by pecking order access to nance, rms should
initially nance innovation by internally-generated cash ow and then by
external funds (rst debt and then equity). However, empirical results so
far available do not reveal a clear-cut picture.
A study focusing on UK industrial rms over the period 1990-2002
(Aghion et al., 2004) provides controversial results. Although rms performing R&D tend to use more debt than rms without R&D activities,
the use of debt declines with the size of the innovative eort and the most
R&D-intensive rms tend to issue equity, thus suggesting a possible nonlinear relationship between innovation and debt nance.
Interestingly, as regards the role played by external equity as an alternative to debt nancing, Schafer et al. (2004) show that German high-tech
rms are more likely to make use of equity than debt when nancing an innovative project, thus supporting the hypothesis of possible credit rationing.
In addition, private equity, such as that provided by venture capitalists, is
not focused on the higher risk stage or novel projects, preference being accorded to rms with a consolidated innovative history; this is captured in
their model by a regular R&D dummy.
As far as the Italian context is concerned, access to nance by Italian
technology-based small rms (TBSFs) seems to be dominated by the pecking
order hierarchy in accordance with Giudici and Paleari (2000), although in
another study of Italian start-ups in manufacturing and services, Colombo
4

and Grilli (2007), while nding support for a nancing hierarchy, also provide
evidence of possible credit constraints, as the amount of credit received by
TBSFs is not sucient to cover investment requirements.
Indeed, problems aecting the nancing of innovative rms may be even
more severe in the case of smaller and younger rms, amongst which the
dominance of the pecking order hierarchy may be more dicult to verify. These rms may have less internal resources for nancing innovative
projects. They may be aected more than large rms by asymmetric information, due to a low reputation or the diculties faced by outsiders in
evaluating their default history. Moreover, small and young rms are likely
to incur higher bankruptcy costs due to their shortage of physical assets
to be used as collateral. Accordingly, some empirical investigations of the
Italian manufacturing sector support the view that nancial rationing may
aect small innovative rms more than medium-large (Ughetto, 2008) or
small non-innovative rms (Magri, 2009).
In addition, nancial institutional factors may play a crucial role in shaping the innovation path, due to the strong relationship between Italian industry and the banking system. While there is evidence that the development
of local banks may aect a rms innovative process and can reduce nancial constraints faced by small rms investing in xed capital (Benfratello
et al., 2008), it should be borne in mind that the use of stock and venture capital markets by Italian rms is still relatively limited compared to
other industrialized countries, and signicant dierences across European
countries emerge (Bottazzi and De Rin, 2002). Also, a shortage of venture
capital for innovative SMEs has been indicated by the European Commission1 as one of the main factors hindering innovation in countries such as
Italy, thus raising important policy implications. Nevertheless, empirical
evidence on the role of venture capital in Europe is not conclusive.
This paper oers a twofold contribution to the empirical debate on the
nancing of innovation. First of all, it provides a comprehensive descriptions
of possible simultaneous patterns which may aect a rms relevant dimensions, namely innovation inputs, innovation output, leverage and protability. By using a Granger-Causality framework we will show that a rms
leverage does not cause innovation output, as proxied by a measure of a
rms successful innovation, while it is rather caused by successful innovation and a rms operating protability.
The second contribution is an original investigation of the determinants
1
Innopolicy Trend Chart, Country report 2008, European Commission, Enterprise Directorate - General

of a rms capital structure based on a panel dataset which links the third
Community Innovation Survey with an administrative data source providing
economic and nancial information collected from balance sheets and income
statements referring to the period 1996-2003.
This paper provides support for the pecking order theory as our rms are
less indebted when operating protability increases, but the use of external
funding increases with their innovative eort. We also nd support for the
existence of credit constrains which seem to aect small innovative rms.
The paper proceeds as follow. A description of the data is presented
in Section Two, together with the presentation of our nal panel of rms.
The adoption of the debt to assets ratio as a measure for a rms capital
structure is also motivated. In section 3 causality patterns of our relevant
variables are explored, while in section 4 we present our empirical model
for a rms capital structure and discuss the econometric results. Section 5
provides a summary of the main ndings and concludes the paper.

Data description

The main source of information is represented by a panel dataset which

links the third Community Innovation Survey (CIS3) with an administrative
data source providing economic and nancial information collected from
balance sheets and income statements referring to the period 1996-2003 for
those rms included in the CIS3 sample of respondents. Our nal sample
is represented by a balanced panel of 2,591 industrial rms, corresponding
to 20,728 non-missing observations (see Table 1). The rms sectoral and
geographical distribution is described in Appendix A, where a comparison
with the CIS3 sample of respondents is provided. Descriptive statistics of
the relevant accounting ratios are provided in Appendix B.

In order to derive additional information about the rms innovative status during the entire time span, the CIS3 sample of respondents was merged
with the CIS2 and CIS4 samples of respondents covering, respectively, the
periods 1994-96 and 2002-04. Combining three CIS waves inevitably leads
to a considerable drop in the number of rms, as CIS3 and CIS4 samples
include the services sector, whereas the CIS2 sample covered exclusively the
industrial sector. As we intend to work with the three-wave panel, our attention has to be limited to the industrial sector, which corresponds to 9,197
rms. Beyond this, CIS information for the period 1994-96 and 2002-04 is

not available for every rm in the panel. The variable reecting innovative
status is thus available for the entire period for a small subset of the rms
in the CIS3 sample of respondents. Limiting analysis to this subset of rms
may seriously aect the robustness of results. It was thus decided to estimate the innovative status of the missing observations. This is pursued
using a Multiple Imputation approach (Rubin, 1987)2 .
The adoption of MI has enabled us to retain an adequate number of observations, which is larger than that obtained with a brute linkage between
the three CIS waves, and it is also suitable for econometric investigation of
lagged eects, dynamic and causality patterns, which would otherwise not
be possible. In fact, it is well known among CIS users that the possibility
of deriving longitudinal information is heavily conditioned by the timing of
data. Most of the qualitative information, including a rms innovative status, is dened over a three-year time span, and quantitative variables, such
as those describing innovative eort, are available for the last year. When
an attempt is made to link two or more CIS surveys, one may end up with
an insucient number of observations for performing reliable econometric
investigations.
In contrast to a prediction derived from a single imputation, MI, which
is based on an appropriate number of random draw imputations, allows one
to take into consideration uncertainty about the true value of the missing
information to be imputed. In this work, we have applied a multiple logistic imputation, which is appropriate as our target variable is dichotomous.
In the RHS of the imputation model we included a set of covariates (rm
size, rm protability, rm R&D and patent propensity, geographical char2

The Multiple Imputation Approach to the estimation of missing values for the innovation variable is focused in a specic chapter of my PhD thesis. Further details are available
on request.

Table 1: The process of selecting the rms

acteristics, sectoral innovative intensity) which, according to the economic

literature, may represent important determinants of a rms innovativeness.
This procedure has allowed us to set up an imputation method which is
crucially focused on economic theory and empirical literature on the determinants of a rms innovation. 3 Also note that a previous study (Bartoloni
and Baussola, 2001) based on a cross-section of Italian manufacturing rms
which also responded to the CIS2 survey, set up a well-specied logistic
model for technology adoption by using a set of explanatory variables which
included the variables used in the present study. In that study the explanatory variables reected the typical adoption mechanism summarized by the
rank and epidemic eects as suggested by Karshenas and Stoneman (1993).
A detailed table providing descriptive statistics for both the reduced and
the full CIS3 sample of rms is reported in Appendix A.
A rms leverage is dened as the percentage ratio of total debt to total
assets. Following the relevant empirical literature, this can be considered a
measure of the extent to which a rm uses borrowing instead of equity in order to nance its activity. It is worth recalling that our leverage index does
not allow us to distinguish between dierent categories of debt according
to the maturity structure or the typology of lender (banks or other nancial institutions). However, we believe this indicator could be adequate for
describing the nancial choices of our panel of rms. In fact, one should consider the strong relationships which have traditionally characterised Italian
industry and the bank system and therefore the possible great relevance of
bank debt within our panel, as also conrmed by the Bank of Italys data.
We also have to stress that our data do not contain information on the
possible role of external equity-holders as opposed to both debt nancing
and self-nancing. However, it should be borne in mind that the use of the
stock market and the venture capital market by Italian rms is still relatively
low compared to other industrialized countries; thus, self-nancing is much
more relevant with respect to external equity nancing in the denition of
the equity aggregate.
3

It is also worth underlining that this procedure has determined an overall good prediction of the innovation variable according with the standard measures used for logistic
regressions (Percent concordant computed with the SAS Logistic procedure does never fall
below the value of 70.8%). This procedure also meets the methodological requirements
stressed by the MI literature (Schafer, 1997; Rubin, 1996), i.e. the need of using a rich set
of covariates in the imputation model, particularly those which represent a specic focus
of the research.

Leverage, innovation and profitability: simultaneity patterns

The primary interest of this study is to analyse the determinants of a

rms capital structure, with particular focus on its propensity to innovate
and protability. However, as the review of the empirical literature suggests,
there is room to believe that causality may be not one-sided as the dynamic
relationships between our focus variables may be crucially aected by simultaneity patterns. Thus, we rst performed a causality analysis based
on the Granger-Causality approach with reference to our panel of industrial
rms. Our aim is to identify possible simultaneity patterns, enabling us then
to move on to the main focus of our analysis. We use a rms debt ratio
(LEVERAGE), given by the percentage ratio of total debt to total assets,
as a proxy for its nancial leverage, and the percentage ratio of operating
margins to total sales (ROS) as a proxy for its operating protability; these
variables are derived from balance sheet information. We also use a dichotomous variable (INN) as a proxy for a rms successful innovation; this
variable is based on the Community Innovation Survey and assumes a value
of one if the rm has introduced technological innovation (product and/or
process innovation) and zero otherwise. We analyse the following pairs of
relationships:

Relationship 1: Leverage and Innovation - Does leverage cause innovation or does innovation cause leverage?

Relationship 2: Leverage and Protability - Does leverage cause profitability or does protability cause leverage?

3.1

Bivariate causality test: methodology and empirical model

We proceed by applying standard bi-directional Granger-causality tests

(Granger, 1969; Sims, 1972) to the issue of the relationships between debt
ratio and protability, innovation and protability and debt ratio and profitability. We use a Vector Autoregressive Representation similar to that
originally proposed by Holtz-Eakin et al. (1988).
Given two variables yit and xit , we consider the following time-stationary
VAR model in order to test whether xit Granger-causes yit :
9

yit =

k yi,tk +

k=1

k xi,tk + uit

(1)

k=1

where: i = 1, , N rms (N=2,591) in years t = 1, , T (T=8), K is

the number of lags and uit = i +t +vit is a two-way error component model.
vit is a serially uncorrelated error term and i and t are rm- and timespecic eects. Thus, we allow for the presence of unobserved heterogeneity
captured by rm-specic eects, but we impose the strong assumption of
homogeneity in the response to changes in the exogenous variable (xed
coecients). Similarly, we specify an identical model to that in Equation
(1) in order to test whether yit Granger-causes xit :

xit =

k xi,tk +

k=1

k yi,tk + uit

(2)

k=1

Finally, we test for causality by specifying a test for the joint hypothesis
H0 = 1 = = k = 0. If the test is rejected, variable X will Grangercause variable Y . Similarly, variable Y Granger-causes variable X if the
joint hypothesis H0 = 1 = = k = 0 is rejected.
In the traditional Granger-causality context the choice of the optimal laglength is important, as it is well-known that lag selection may signicantly
aect the results. In our case, due to the short time dimension of our panel
of rms we decided to adopt an empirical selection method: starting from a
maximum of K = 4, we tested for dierent lag lengths. Results for one to
three lags are reported, although two lags seems to be a reasonable selection4 .
We adopt the GMM framework when the kind of relationship to be
tested is linear. More specically, we use a GMM-sys estimator (Arellano
and Bover, 1995; Blundell and Bond, 1998) for the specication both in rst
dierences and in levels. This approach combines a larger set of instruments
with respect to a traditional IV estimator or a standard rst dierence
GMM estimator and can therefore result in greater eciency, provided the
assumptions of white noise error and lack of correlation between the set
of instruments and the error term are valid. We present in the tables of
results the Sargan statistic as a test for the validity of the over-identifying
4

Bearing in mind the short time span of our panel, we considered the signicance of
further lags in order to select the appropriate lag structure.

10

restrictions of the GMM estimations and two other tests for rst- and secondorder serial correlation (m1 and m2 ).
Unfortunately, the conventional Granger-causality methodology has to
be modied in our case, as one of the variables under investigation (INN) is
dichotomous. This means that a dynamic binary model has to be used when
testing for causality which runs from the other two (continuous) variables to
innovation. With reference to the rst shortcoming we decided to adopt a
random eect estimator. Although it rests on more restrictive assumptions
compared to a xed eect estimator, it nevertheless allows us to overcome
the incidental parameter problem in a non-linear context. As for the problem
of initial conditions, it is quite well established that ignoring the correlation
between the initial state of each unit and the rm-specic heterogeneity
term, when in fact it is present, may determine problems of consistency in the
ML parameter estimates (Anderson and Hsiao, 1982; Nerlove and Balestra,
1996). However, attempts described in the empirical literature available so
far typically make strong assumptions about the possible functional form
in order to model initial conditions as endogenous, and so the possibility of
deriving misleading results is not completely avoided5 . We decided to avoid
the initial conditions problem, for two reasons. Firstly, at this stage our focus
is on possible mutual interdependence between selected pairs of variables.
We do not intend to estimate a full model for innovation, which would require
the inclusion of other possible determinants and control variables. In this
context, we believe that the need to model initial conditions is in fact less
stringent. Secondly, the statistical techniques typically proposed in empirical
applications (Heckman, 1981; Wooldridge, 2005; Stewart, 2007) rely on presample information for modelling initial observations. As information on our
sample of rms starts in the rst year of the panel, we should remove one year
from our time series, thus reducing the reference period for the likelihood
estimates to a seven year time-span. This further loss of information could
aect the power of our causality tests.
Nevertheless, in order to provide more reliable results with respect to
the relationships involving the innovation variable, we provide additional
causality tests by using an alternative proxy for innovation: the accounting
5

Kazemi and Crouchley (2006) provide an historical review of the properties of modelling initial conditions, and also develop an empirical application for a panel of economic
growth data, by using a variety of model specications. They nd that even though ignoring initial conditions results in an upward bias of the state dependence and a downward
bias in the coecients of the explanatory variables, models based on dierent assumptions
regarding initial conditions provide rather dierent estimation results.

11

values of intangible assets (INT ASS)6 . We are interested in testing for this
dierent measure of innovativeness for several reasons: rstly, because it is
an input rather than an output measure of innovation, in that this variable
includes goodwill, intellectual property rights, patents, trademarks, R&D
investments, website domain names and, typically, long-term investments
which may describe a rms innovative eort; secondly, because it is a continuous variable, thus enabling us to test for the sensitivity of our causality
tests to changes in the estimation techniques (GMM instead of ML estimations); nally, because information on intangible assets derives from an
administrative data source, in contrast with our INN variable which derives
from a statistical survey; thus, we can also check for the sensitivity of our
results to the use of dierent sources of information.

3.2

Empirical results

Relationship 1: Leverage and Innovation

Our results indicate that a rms debt ratio is signicantly Grangercaused by innovation (see Table 2, test 1), by considering rst innovation
as the right-hand-side variable. The Wald statistics of non-causation are
strongly rejected in the dierent specications, even though the impact of
innovation with lags higher than one is found to be no longer signicant.
The negative coecients of the INN variable lagged one year indicate that
introducing successful innovation has a negative impact on a rms future
leverage. Although limited to a very short time span, this result seems quite
robust, as tests for residual autocorrelation and the validity of the instruments used are both satisfactory. We performed an additional causality test
(test 2) by using INT ASS as an explanatory (continuous) variable. The
causal relationship is conrmed as being strong and the negative sign of the
one-lag coecient reveals that having invested in intangible assets, including
R&D and other innovative eorts, again decreases a rms leverage.
The reverse causality relationship, i.e. considering innovation as caused
by leverage, does not hold (Table 3). Results from the Wald test strongly
reject the hypothesis of joint signicance of the LEVERAGE coecient in
all the lag specications adopted. Conversely, the test performed using our
alternative (input) measure of innovation tells a rather dierent story, as
variable LEVERAGE is now strongly causal, at least in the short run. Thus
6

Although innovation inputs such as R&D expenditures are covered by the CIS survey,
this information is not available for the entire period under analysis and thus is not suitable
for causality tests.

12

Table 2: Does Innovation cause Leverage?

13

Table 3: Does Leverage cause Innovation?

14

Table 4: Does Protability cause Leverage?

15

Table 5: Does Leverage cause Protability?

16

the results of these bi-directional causality tests suggest that innovation

is causal when it is used as an output (INN). In contrast, our tests provide
strong evidence of dynamic feedback eects between innovation and leverage
when innovation is used as an input (INT ASS).
Relationship 2: Leverage and Protability
Results reported in Table 4 show quite clearly that a rms protability,
as measured by the return on sales (ROS) index, does cause leverage. This
interpretation is strongly conrmed by the Wald statistics associated with
the entire set of lag specications. In accordance with the pecking order
theory, the eect of protability on leverage is negative and persists over
time. The sign of the coecients remains signicantly negative even after
two years in all the dynamic specications presented.
The reverse relationship is not fully conrmed by the empirical tests,
as causality may be observed only in the one-lag specication (Table 5).
Possible simultaneity patterns between LEVERAGE and protability are
limited to the short run, whereas in a longer time span, here necessarily
limited to the two- and three-lag specications, the only conrmed causal
relationship runs in the opposite direction.
Overall, our results seems to support the view that a rm which innovates successfully can account on a ow of internal resources which may be
reinvested in new opportunities (Relationship 1 ). This suggestion is also reinforced by the evidence that leverage is negatively associated with a rms
protability (Relationship 2 ). Thus, one can argue, on the basis of these
causality tests, that innovation may enhances a rms ability to self-nance,
provided that an adequate ow of prots is generated. The dierent picture
which emerges when an input measure of innovation is adopted and when we
look at the bi-directional link with the debt ratio variable, is evidence of the
possible two-way relationship characterising a rms nancial choice and its
engagement in long-term innovative investments, better captured by an input measure. Conversely, no causal eect from a rms leverage is registered
when we adopt the dichotomous INN variable (an output measure), which
is thus probably less appropriate for capturing any eect deriving from a
rms nancial structure within the short time span of our panel.

The leverage equation

The causality analysis presented in the previous Section indicates that a

rms capital structure is driven by both innovation and protability. These
17

results enable us to set up an empirical model which can explain a rms

leverage, as proxied by our debt ratio, where innovation and the rms profitability enter as explanatory variables, as suggested by our causality tests.
We start by analysing a static linear model which, in accordance with
the relevant literature, takes into account a rms performance in terms of
both protability (ROS) and innovative propensity (INN). We also expect
a rms characteristics in terms of size, age, nancial eciency (IR) and
asset structure (INTANG TA, the percent ratio of intangible assets to total
assets) to play an important role in explaining a rms capital structure7 .
Then, we will proceed by specifying a dynamic model which takes the role
of past nancial structure into account when analysing the impact played
by other possible determinants. Infact, descriptive statistics (not reported
here) show quite clearly that nancial behaviour was rather conservative
during our time span, our industrial rms persistently maintaining a highleveraged structure. This means that the lagged dependent variable needs
to be explicitly considered in the econometric investigation at the rm level.

4.1

The static model

In this section we rst concentrate on a parsimonious specication of our

leverage equation, which can be specied as follows:
LEV ERAGEit = 1 IN Nit1 + 2 ROSit + 3 SIZEit
+4 AGEit + 5 IN T AN G T Ait1 + 6 IRit

(3)

+7 Tt + i + vit

where the subscripts i and t identify, respectively, rms and calendar

time, Tt is a time dummy common to all rms, i is the individual-level
eect which represents rm-specic heterogeneity and which may or may
not be correlated with the set of explanatory variables, and vit is the usual
disturbance term.
Model 1 in Table 6 corresponds to the specication adopted in Equation
(3). Instead, in model 2 we have improved our leverage specication with
additional information. In particular we want to analyse:
7

Variable INN and INTANG TA have been lagged one period in order to capture
the eects of past decisions on both the investments in intangible assets such as R&D
expenditures and the decision to introduce innovation.

18

- the eect on a rms nancial structure of its geographical location

as proxied by the usual set of area dummies. We expect that rms
located in the northern regions (traditionally characterised by higher
growth rates) should be able to access external nancing under better
conditions and thus have higher levels of leverage;
- the possible role played by the institutional context characterising the
lending market in the industry sector. This is proxied using the real
annual growth rate of bank lending to industrial rms. The LENDING GR variable may be considered an indicator of credit accessibility,
which is crucially linked to the economic cycle. Bank lending slowed
down considerably as of the late nineties (see Figure 1) as a rst signal
of the early 2000s economic recession. We expect that an increase in
the growth of bank lending may boost rms investment decisions and,
through this route, aect their leverage levels positively.

Figure 1: Real growth rate of bank lending to industrial rms (percentage

change on the previous year)

Our estimations highlight some important results regarding the role of

a rms performance in terms of innovation and protability. However, in
other cases, results are more uncertain. More specically, a rms profitability exerts a negative and relevant impact on leverage decisions. The
coecient of variable ROS is large and quite stable across the dierent spec19

ications, thus signalling that a higher level of operating protability is associated with a lower debt ratio. The view that more protable rms are
more reliant on internal resources with respect to external nancing is in
line with the theoretical predictions of the pecking order mechanism and,
also, with results of the bivariate causality tests provided in the previous
section. In addition, it should be noted that in all the specications the
interest rate payments-to-sales ratio (IR, a variable reecting the position
of a rm with respect to external nancial resources) presents the expected
positive sign, as higher debt intensity is likely to be associated with a higher
interest burden.
The eect of past innovation (L.INN) in model 1 is not signicant according with the conventional signicance levels . However, when we take
industry structure (model 2) into account by including industry dummies,
the signicance of the INN coecient turns out to be noticeably improved.
Our results conrms the negative association between variable INN and
LEVERAGE which also emerged in the causality analysis, thus supporting the view that more innovative rms tend to be more reliant on internal
resources, possibly due to high uncertainty associated with innovative investments rendering external nancing more costly.
Intangible asset intensity, as proxied by the INTANG TA ratio, may be
considered an alternative (continuous) proxy of a rms innovative eort,
as R&D expenditures are recorded in this balance sheet item. In addition,
following the literature on moral hazard and collateral, it may be considered
an indicator of the role of immaterial versus physical assets in determining
a rms capital structure. The eect of this variable on leverage is not
clearly determined within the empirical debate. Following the literature
on collateral, the expected sign is negative, as the higher the immaterial
component of a rms capital structure, the higher one would expect the
bankruptcy risk associated with external nance to be. When this variable is
assumed as a proxy for the intensity of a rms innovative eort, the expected
sign should be positive in accordance with the pecking order argument,
as rms need external nancing when innovation eorts are particularly
costly and internal funds are not sucient to cover the entire investment.
Our results show a positive and signicant eect of lagged intangible asset
intensity on leverage, thus supporting the view that this variable should
be considered a proxy for the pecking order mechanism, rather than an
indicator of a rms bankruptcy risk.
This positive eect on leverage is not in contrast with the negative eect
shown by the INN variable. In fact, these two variables capture dierent
patterns: dichotomous INN is a proxy of a rms innovation success, while
20

Table 6: Leverage equation: static model

21

continuous INTANG TA measures the size of the innovation eort. Therefore, although it is correct to expect that a rm which has successfully
innovated might have generated internal resources in order to nance future
activities, the ow of internal revenues may be insucient when the size of
the investment projects increases, thus making the use of external nancing
necessary.
As for the role of SIZE and AGE, these are traditionally considered as
proxies for a rms probability of default. The relationship between leverage and dierent proxies for a rms reputation or quality may be dicult
to assess. In general, the agency costs of debt are expected to be higher
for those rms with a lower reputation, such as those which are smaller
or less established, and, therefore, a positive relationship between a rms
debt ratio and a measure for credit worthiness such as size or age should be
expected, according to this interpretation. However, empirical evidence is
not conclusive. Aghion et al. (2004) found a positive relationship between
size and the debt ratio, while according to Magri (2009) the eects of both
age and size are almost irrelevant in determining a rms nancial leverage. Heyman et al. (2008) found a negative relationship between the debt
ratio and size measured by total assets in logarithm terms, while Titman
and Wessels (1988), emphasising the role of debt maturity, found that the
relationship between size and a measure of short-term debt is negative, thus
implying that small rms tend to use signicantly more short-term nancing
with respect to large rms.
In fact, a negative relationship between LEVERAGE and a measure of a
rms reputation is explained on theoretical grounds by the possibly higher
agency costs of equity (and long-term debt) with respect the cost of (shortterm) debt which may characterise rms with less reputation (Smith and
Warner, 1979; Pettit and Singer, 1985). Thus, in accordance with these
predictions regarding the determinants of debt maturity, we would expect
that small and less established rms prefer to borrow in the short term
rather than issuing new equity or even long-term debt. Unfortunately, our
data do not allow us to determine the maturity structure of a rms debt, so
we cannot provide evidence on this particular aspect of the empirical debate.
The eect of rm SIZE is negative and signicant, when using the specication in model 2, although the size of the coecient remains quite small.
A possible negative relationship between LEVERAGE and factors which are
connected with a rms reputation may be veried on empirical grounds. It
has been argued that problems connected with a rms possible default may
be reduced by borrowing short-term (Diamond, 1991). Moreover, in an industrial system based on strong relationships with banks, as in Italy, it may
22

be easier for a rm with a moderate reputation8 to renegotiate its debt than

in a system based on non-bank lenders (Hoshi et al., 1990).
Although, given the nature of our data, a direct investigation is not
possible, we think that the potential role of short-term bank borrowing could
explain the negative relationship observed between debt ratio and SIZE (or
AGE) in our panel of rms, thus supporting the view that smaller or younger
rms are likely to be more reliant on (short-term) debt.
Giving the relevance of this aspect, we have also tried to further investigate the role of rm size by dividing our sample into three size classes9 . The
signicance of the split has been tested for by computing the Chow test on
the three groups separately.
The most important result observed for the split sample is the eect
of innovation on leverage: having introduced innovation negatively aects
a rms debt ratio in the group of small rms but not in the other two
groups, where the eect of past innovation on the debt ratio is not signicant.
It could be useful to analyse this result in association with the eect of
our indicator of credit accessibility (LENDING GR). In general, the eect
on LEVERAGE is positive, indicating that the more favourable the credit
supply, the higher the level of external nancing. However, this positive
relationship is not veried for small rms, thus indicating that changes in
lending conditions do not much aect their nancial structure. These results
seem to indicate possible diculties in accessing external nancing for small
innovative rms, which are more likely to rely to a greater extent on internal
nance even when credit accessibility is wider.
Some dierences can also be observed between medium and large rms.
For example, the impact of credit accessibility on LEVERAGE is signicant
in the group of medium rms, whereas it is not signicant for the large
rms. This dierence in behaviour is possibly explained on the grounds
that large rms take advantage of a preferred relationship with the (bank)
system compared to the medium rms. In fact our results show that the
nancial structure of large industrial rms is not sensitive to change in the
short-term availability of bank credit, whereas it is for medium rms.
8
It is worth stressing the fact that our data set is based on a balanced panel of rms
which have operated continuously in the industrial sector during our time span. This
characteristic makes it plausible to assume that our rms are, on average, of relatively
good quality.
9
Small rms are those with no more than 50 employees; medium rms are those with
between 50 and 500 employees, and large rms have more than 500 employees. Groups
are determined on the basis of the average size during the period 1996-2003. Results do
not change when allowing the rms to enter and exit the three size classes.

23

Other evidence which may corroborate the hypothesis of a preferred

relationship between large rms and the credit market is to be found in the
dierent role played a rms reputation as proxied by variable AGE: having
a long history does not matter in explaining a rms leverage for large
rms, whereas it does for small and medium rms. However, the sign of
the relationship is negative, thus indicating the possible higher relevance of
short-term nancing for less-established rms within the groups of small and
medium rms10 .
Finally, it is worth noting the increase in the explanatory power when
moving from model 1 to model 2, where regional and industrial dummies are
included. The eect of localisation on a rms leverage is as we expected:
rms located in the southern regions are generally less leveraged with respect
to their counterparts in the central-northern regions. It is worth noting that
the dummy associated with the northwest regions shows a negative coecient with respect to the northeast, which is the reference dummy. This could
be due to the high dynamism which has characterised the north-eastern regions during our time span, and which may have determined favourable
access to external nancing for those rms in the northeast. The situation
of favourable growth in north-eastern industry may explain the higher debt
ratio of the rms in our panel compared to the northwest of Italy.

4.2

Further investigation: long-run patterns

In this section we provide further evidence conrming the robustness of

the previous results. We estimate an additional model specication based on
time averages of our key variables (Table 7). Although we are aware that our
time horizon is relatively short (and, thus, any conclusion about the longrun behaviour of the observed relationships must be derived with caution),
the intuitive meaning of this additional test is that when the estimated
relationships can be conrmed by using a time averaged specication, we
can reasonably assume that they should hold in the long run as well.
Furthermore, the use of a cross-sectional approach is particularly suited
to our purpose, as it allows us to recover additional information from the
Community Innovation Survey which is not provided on a longitudinal basis
and thus cannot be used within a panel approach. Conversely, by using a
10
We achieve the same conclusion by using another specication (not reported) where
the variable SIZE is included in the set of regressions by size class, as an additional test
for the role of a rms reputation in explaining LEVERAGE. We found that the coecient
of SIZE is negative and signicant for the groups of medium rms, whereas it is not for
the group of large rms.

24

cross-sectional approach, we can plausibly consider some rm-specic variables which were collected with the CIS3 survey as additional determinants
of a rms leverage11 . More specically, we here estimate an OLS specication for a rms leverage which takes into consideration alternative measures
of its innovation. Thus, the following variables are in turn tested for:
- INN 1996: this is the usual dichotomous innovation variable referring
to the beginning of our time span. It is intended to capture the eect
of early successful innovation on the average debt ratio.
- PREV INN: this is a new dummy variable which assumes value one
when the rm introduced at least one technological innovation in at
least four years of the entire period and zero otherwise. It is designed
to capture the eect of frequent successful innovation.
- R&D CIS3: this is a dummy variable derived from the CIS3 survey.
It is an input indicator of innovation and assumes value one if the rm
performed systematic R&D activities during the period 1998-2000 and
zero otherwise. It is intended to capture the eect of non-occasional
R&D activities on a rms debt-ratio.
- INNSALES CIS3: this is a continuous measure of output innovation.
It is given by the share of total turnover due to products introduced
during the period 1998-2000 which are new to the reference market.
A rms group membership (GP CIS3) is also added to the list of regressors, as it is reasonable to suppose that being part of an industrial group
may generate synergies, both nancial and operative, within the group, thus
reducing the need for external nancing.
In addition, the role of nancial constraints to innovation in shaping a
rms nancial structure is another interesting aspect we want to test for.
As we have stressed previously, theories on corporate leverage do not
focus directly on innovation. In addition, the lack of a clear-cut denition
of nancial constraints has made it dicult to nd a broad measure of such
constraints. The conventional way to investigate empirically whether nancing constraints matter for innovative activity is based on the standard
methodology for the identication of excessive investment sensitivity to cash
11

In fact, it is worth recalling that information collected with the CIS3 survey refers
to the three-year period 1998-2000, which falls in the middle of our panel. The implicit
hypothesis is that this additional information at the rm level can reasonably be assumed
to be time invariant during our time span.

25

ow variations. Within this tradition, a substantial body of empirical literature has demonstrated that small rms are more likely to be nancially
constrained compared to larger rms (Hall, 2002; Ughetto, 2008). The hypothesis that small innovative rms are constrained in accessing external nance seems to be supported even when more recent methodologies, adopted
as alternatives to the standard cash ow analysis, make use of innovation
survey data (see, for example, Canepa and Stoneman (2007) who used data
from the second and third UK CIS). However, there is a lack of empirical
evidence concerning Italian rms.
We have derived a qualitative variable intended to capture a rms subjective perception of the presence of nancial constraints to innovation from
the CIS3 questionnaire. Thus, a dichotomous variable (FIN CONST CIS3)
assuming value one when the rm considers relevant the presence of at least
one economic obstacle to technological innovation12 and zero otherwise is
included in our OLS leverage specication.
The rst relevant result is that a negative relationship between innovation and LEVERAGE is conrmed when using both the INN 1996 and
the PREV INN variables: in general rms which introduced a technological
innovation at the beginning of the period or on a frequent basis tend, on
average, to use more internal nance. Results by size class conrm that innovation is mainly nanced with internal resources by small rms, whereas
this relationship is not found signicant for the groups of medium and large
rms. Unfortunately, variable R&D CIS3, indicating whether the rm has
undertaken systematic R&D activity, does not give any useful indication;
in fact it is highly insignicant. This result is however in part as expected,
due to the well-known scarcity of Italian rms conducting R&D activity in
structural laboratories (less than one quarter of our sample).
Another interesting result linking a rms innovation and leverage is the
positive impact of the variable INNSALES CIS3, measuring the share of
a rms total sales due to innovative products. This is a measure of the
economic return following the introduction of a product innovation, as a
rm is expected to show a positive value of this variable when an innovative
product has been successfully introduced for the rst time on the reference
market. In addition, this could also be considered an indirect measure of
the innovative eort connected with the commercialisation of a product innovation, as the higher the share of total sales which can be related to new
products, the more strategic a rms innovation activity should be and, in
12
The list of obstacles to innovation includes: excessive perceived economic risks, innovation costs too high and lack of source of nance.

26

Table 7: Leverage equation: OLS estimations

27

the same way, the higher the need for nancial resources required to develop
an innovative project should also be. According to this interpretation, it
is not surprising to note that the relationship with our leverage indicator
is positive, indicating that a higher impact in terms of revenues generated
from the development and introduction of a new product is likely to be associated with the need for a higher level of external nance. This positive
relationship holds both for small and large rms, although the coecient
size is higher for large rms, the latter also revealing a higher share of total
turnover due to innovative products. Unfortunately, the signicance of the
relationship is uncertain for the group of medium rms.
The positive association of INNSALES CIS3 with a rms leverage reminds us of the positive association emerging when the innovative eort is
measured by using the share of intangible assets to total assets, which is
a measure of input. This evidence, together with the conrmed negative
relationship between a rms protability and its debt ratio, represent quite
a strong conrmation of the possible non-linear relationship linking innovation to the external nance requirement and a further proof of the pecking
order hypothesis governing access to nancial resources.
The inclusion of the dummy variable indicating whether a rm belongs to
an industrial group, as an additional leverage determinant based on the CIS3
survey, conrms our expectations, as the coecient is negative, indicating
that rms forming part of an industrial group use more internal resources,
probably due to the positive synergies within the group generating greater
availability of self-nancing. OLS regressions by rm size indicate that the
negative relationship between group membership and a rms debt ratio
is statistically signicant for the group of medium rms, whereas it is not
veried for small and large rms.
Finally, the eect of nancial constraints to innovation on leverage, as
proxied by the FIN CONST CIS3 dummy, is analysed. In general, the observed positive relationship with a rms leverage is somewhat counterintuitive; one would expect that in the presence of nancial constraints a rm is
likely to use more internal resources, thus suggesting a possible negative relationship. However, our empirical model has not been designed to provide
a specic test for the sensitivity of a rms leverage to nancial constraints,
so the presence of a few inconsistencies cannot be considered conclusive. In
fact, our dummy variable refers to the rms subjective perception of its
particular nancial position, so a positive coecient indicates that perceiving ones rm to be nancially constrained is a consequence of being highly
leveraged and thus reects a fragile nancial structure as proxied by a high
debt ratio.
28

Rather, the possible role of nancial constraints to innovation is suggested by a complementary interpretation of the regression results, with
particular reference to results by rm size. In fact:
i) while in general innovation is negatively related to a rms leverage
(implying that the rm should use more internal resources than debt when
introducing an innovation), results by rm size indicate that the coecient
of the INN variable is negative and signicant only in the group of small
rms (see the panel data model in Table 6 and the cross sectional model in
Table 7). This result is conrmed even when we use a model specication
(not shown here) including only variable INN as regressor. These results are
consistent with the view that nancial constraints do not aect innovation
per se, but only innovation carried out by small innovative rms as opposed
to medium and large rms.
ii) with reference to our qualitative indicator of nancial constraints to
innovation (FIN CONSTR CIS3), the results by rm size shown in Table
7 (corresponding to the OLS specication) indicate that the coecient of
the nancial constraints dummy is signicantly positive for the medium and
large rms, thus suggesting that for them a high level of indebtedness may
represent an obstacle to nancing future innovative projects with external
funds, whereas it is not signicant for small rms, which are more likely to
rely on internal resources to nance innovation (as suggested by the negative
association between INN and the level of leverage). This result is conrmed
even when we replace the dichotomous INN variable in the leverage model
with a continuous measure of innovation output (INN SALES CIS3).
We interpret these results as evidence of the fact that within the Italian manufacturing sector small innovative rms may face higher nancial
constraints compared to medium and large rms.
iii) when focusing specically on small rms, results show that the sensitivity of leverage to a rms protability is higher in the group of innovative
rms with respect to non-innovative rms; indeed the coecient of the ROS
variable is higher, in absolute value, for the innovative group, here dened
as rms which have frequently innovated during our time span 13 .
On the basis of this additional result one might expect that small innovative rms are probably more willing to rely on internal resources because of
the higher cost of capital associated with risky innovative activities, which
may discourages them from relying on debt.
13

A higher coecient associated with the ROS variable in the group of small innovative
with respect the group of small non-innovative rms is also conrmed when using the panel
data specication corresponding to model 3) (not shown here for the sake of brevity).

29

4.3

The dynamic model

The estimation of a dynamic linear model which takes the role of past
nancial structure into account requires the use of instrumental variables
in order to handle the possible correlation between the lagged dependent
variable and the error term.
We decide to present a parsimonious equation, which corresponds to
the specication adopted in Equation (3), apart from the eect of lagged
leverage, which has been added in the present case. In so doing, we can
provide a direct comparison with results obtained with Model 1 in Table 6 as
we can isolate the eect of the lagged dependent variable, namely persistence
patterns, in determining a rms capital structure.
We present a full set of specications which includes pooled OLS, xed
and random eect estimations - which are noticeably inconsistent due to endogeneity problems but important for comparative purposes - and consistent
estimations based on the GMM approach, the latter beeing more ecient
than the traditional IV method due to the exploitation of additional moment
conditions, provided that the set of over-identied restrictions is valid.
Looking at the estimation results (Table 8), the rst important point
to emphasize is the large positive coecient of the lagged leverage variable.
The OLS and FE specications are generally recognised as being biased in
opposite directions (Bond, 2002); thus they may provide a plausible range
of variation for the true level of leverage persistence. Our estimations
conrm this expectation, with a coecient for lagged leverage equal to 0.9
in the OLS specication and 0.5 in the xed eect model, while the RE
specication presents a coecient which is in line with the pooled OLS
estimate. A xed eect specication is a plausible choice, as the hypothesis
that the constant term is equal across rms is rejected on the basis of an Ftest and, in addition, the correlation between rm-specic xed eects and
covariates is quite important (0.61). As concerns the RE specication, the
contribution to total variance of the random eect is estimated as beeing
quite modest ( = 0.005), causing doubt as to the appropriateness of a
random eect model specication. A Lagrange multiplier test does not reject
the hypothesis that u2 = 0 .
Bearing in mind this useful information concerning a possible correct
model specication, we now proceed to analyse the results based on GMM
estimations. We have estimated three dierent GMM approaches. In the
rst (model 4), the Arellano-Bond rst-dierence estimator is adopted. Here
the lagged leverage variable presents a lower estimation with respect to the
others; however the Sargan test on the appropriateness of over-identifying
30

Table 8: Leverage equation: dynamic model

31

restrictions is clearly unsatisfactory, thus casting doubts on the validity of

the instruments used for the dierence equation. In the second model (model
5), the standard system specication, which uses both lagged levels for the
dierence equation and lagged dierences for the level equation, is presented
(Arellano and Bover, 1995; Blundell and Bond, 1998). Here the lagged
leverage presents a much higher coecient; however, the use of both the
lagged levels of the debt ratio for the dierence equation and the lagged
dierences for the level equation continues to be inappropriate, according to
the Sargan statistic. We suspect that the high persistency of our leverage
indicator causes lagged levels of debt ratio to be poor instruments for the
dierence equation. Thus we have tried to selectively reduce the number of
moment conditions. In the adjusted system equation presented in model 6,
we use the second lag of both debt and total asset variables as instruments
for the dierence equation and the dierences of these variables in the level
equation. Both variables enter the leverage denition, the former being
the numerator and the latter the denominator. This choice seem to be
appropriate, as suggested by the higher p-values of the Sargan test associated
with this specication.
In general, in addition to strong persistence in the debt structure, our
estimations conrm the results based on the static specication. More specifically, a rms protability exerts a negative and relevant impact on leverage
decisions even when past debt structure is taken into account. The eect
of variable ROS is large and in line with the static specication. A rms
innovative intensity (INTANG TA) and interest burdens (IR) are conrmed
as being signicant determinants with the expected signs, even though the
size of the relative coecients is much smaller than that based on the static
model.
When we move on to analysing the eect of past innovation, we obtain more controversial results. In our GMM estimations the coecient of
lagged INN is still negative, although not signicant at conventional significance levels. Nevertheless, the xed eects model shows a negative and
signicant coecient, thus supporting the view that more innovative rms
tend to be more reliant on internal resources, possibly due to high uncertainty associated with innovative investments rendering external nancing
more costly.
The unsatisfactory results provided by the consistent estimations can
possibly be explained by the characteristics of our innovation variable, which
is dichotomous and therefore not an ideal proxy for a rms innovation eort.
This problem may also be amplied by the strong explanatory power of the
lagged dependant variable, which may dampen the direct eect of variable
32

INN.
Our results, based on a dynamic specication, show that a rms leverage
is not signicantly aected by SIZE, thus conrming results based on our
static model: the estimated coecient is generally either not statistically
signicant or imprecisely estimated using a GMM system specication. As
for a rms AGE, the eect is negative and signicant, as shown by our
preferred specications in the GMM sys adj and the FE models.

Conclusions

We have investigated the determinants of a rms capital structure, paying particular attention to the role played by the rms innovation and profitability. An administrative data source, derived from balance sheet information for a panel of 2,591 industrial rms operating in Italy during the period
1996-2003, has been explored and a measure of a rms leverage selected,
on the basis of which we have been able to assess the relative importance of
external funding (debt) with respect to internal funding as a share of total
assets.
The role of a rms adoption of innovation has been examined by using
both a qualitative indicator, an output measure derived from the Community Innovation Survey indicating whether a rm introduced or did not
introduce technological innovation during our relevant time span, and an
input measure, given by the book value of intangible assets as a proportion of a rms total asset value. As the dynamic relationships between our
focus variables may be crucially aected by simultaneity patterns, we rst
performed a causality analysis based on the Granger-Causality approach.
Results support the view that a rms leverage is caused by both innovation
and protability, while no causal eect is registered as running from a rms
leverage to either protability or to our measure of innovation output.
We then concentrated on the analysis of an econometric model of a rms
leverage. Dierent specications, both static and dynamic, have been tested
for, in order to estimate short- and long-run eects.
Overall our results indicate that Myers and Majlufs pecking order mechanism dominates access to nancial resources. In particular:
i) More protable rms tend to use internal nance more, as implied by
the negative relationship linking a rms debt ratio and return on sales. The
role of a rms protability in reducing the need for external nance characterises all rms, regardless of size as measured by employment, although
large rms show a lower sensitivity of leverage to prot variations. This re-

33

lationship is robust to dierent model specications; coecients associated

with the ROS variable are large and signicant even when lagged leverage is
taken into account in our dynamic specication, and this is also conrmed in
the long run, as suggested by our OLS specication based on time averages.
ii) The need for external nance increases with the innovative eort, as
is shown by the fact that in all the econometric specications, both static
and dynamic, a positive relationship is found between alternative proxies for
innovation intensity, based on measures of both innovative input (the share
of intangible assets to total assets, derived from accounting information)
and innovative output (the share of a rms sales due to the introduction
of a product innovation, derived from CIS data). This result, which holds
regardless of a rms size, indicates that when internal resources are not
sucient to cover large innovative projects, debt nancing is required.
Unfortunately, given the characteristics of our data set, we cannot test
for other important implications of the pecking order theory regarding in
particular the trade-o between dierent sources of nance according to the
maturity structure of debt and the possibility of issuing equity nance.
Our results also show that credit rationing issues do not seem to prevail
in association with innovation per se. However, credit constraints could represent a serious problem for small innovative rms, which are more likely to
rely on internal funds rather than debt. This relationship has been tested for
by using alternative proxies capturing dierent timings of innovation. Given
the relevance of internal resources for small innovative rms, we have also
shown that nancial factors perceived as constraints to innovation investments do not seem to aect nancial structure, while they do in the group
of medium and large rms. Unfortunately, we do not have any elements to
determine whether and to what extent the presence of credit rationing may
actually constrain the size of the innovative eort in small rms. Our results
also show that for small innovative rms, access to debt nancing could be
more dicult for small rms which are not engaged in innovation, given the
higher sensitivity of leverage to operating protability. All these elements
seem to indicate an unfavourable situation for small innovative rms when
accessing debt nancing.
In addition, our empirical investigation provides a comprehensive description of the role played by structural factors such as sectoral characteristics and localization in aecting a rms capital structure. Evidence does
not directly relate to a rms hierarchical selection of nancial alternatives
as suggested by the pecking order theory, but does give us a way to account
for the most basic stylized facts characterizing the Italian industrial sector.
The econometric investigation at the rm level shows that capital struc34

ture is highly persistent over time. Results from our dynamic specication
show that lagged leverage captures a consistent part of the model variability,
with a large and signicant coecient in our preferred consistent specication (GMM sys adj).
The relationship between alternative measures of a rms reputation and
leverage is negative due to the characteristics of our credit market, mainly
dominated by the traditional banking system (limited venture capital); we
suspect that this relationship actually captures the role of short-term borrowing, which is less costly with respect to long-term debt or equity and is
thus more likely to be used by smaller and younger rms with respect to
more established rms. This evidence, which is robust to dierent model
specications, also seems to hold in the long run, as suggested by the results
based on our cross sectional specication.
Finally, we have found evidence that regional gaps signicantly aect
a rms nancial decisions, in that rms located in the northern regions
show a debt ratio which is higher, on average, with respect to those in the
centre and south. Positive dierentials also characterise the leverage of rms
located in the northeast compared to the northwest.

Acknowledgements
A special thanks to Paul Stoneman for helpful comments on a earlier draft of this
paper. I would also like to thank participants at the DRUID Summer Conference
2010, Imperial College Business School, London, at the Trans-Atlantic Doctoral
Conference 2010, London Business School and two anonymous referees for their
fruitful remarks and suggestions. Finally, Id like to acknowledge the support by
Giulio Perani, director of the Innovation and R&D Statistic Unit and Caterina
Viviano, director of the methodological unit at the division for statistical registers
and by the Directorate of Regional Oces of the National Institute of Statistics for
providing access to the data set.

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38

CIS samples of respondents and final panel of

firms: descriptive statistics

39

Variables definition and summary statistics

40