Banks' Interventions and Firms' Innovation: Evidence from Debt Covenant Violations

We examine the effect of banks' interventions on corporate innovation and firms' value via the lens of debt covenant violations. Banks' interventions have a significantly negative effect on the quantity of innovations but no significant effect on their quality. The reduction in quantity is concentrated in innovations that are unrelated to the violating firm's core business, which leads to a more-focused scope of investment in innovation and ultimately an increase in the firm's value. Human capital redeployment appears to be a plausible underlying mechanism through which banks' interventions refocus the scope of innovation and enhance a firm's value. Our paper sheds new light on the real effect of bank financing.