Internal and External Financing of Innovation: Sectoral differences in a longitudinal study of European firms

Purpose

Successful innovation requires a significant financial commitment. We therefore investigate the relation between internal and external financing and the degree of innovation in European firms.

Methodology

We carry out an empirical investigation using a longitudinal data set including 146 large, quoted, European firms over ten years, resulting in 1460 firm years.

Findings

We find that only firms in the energy sector will be more innovative when they are profitable. For the sectors of basic materials, manufacture, and construction, services, financial and property services, and technology and telecommunications, profitability is negatively related to innovation. External financing in the form of debt reduces the focus on innovation in profitable firms.

Research Implication

We analyze the findings through the lens of evolutionary economics. The model is not valid for firms in the consumer goods sector, which indicates a need for adapting the model to each sector. We conclude that the impact of profitability on innovation varies across sectors, with debt financing as a moderating factor.

Originality

To best of our knowledge, this is the first study analyzing internal and external financing and the degree of innovation in European firms on a longitudinal basis.