Title : Banking Crisis, Venture Capital and Innovation

Author : Chun-Yu Ho(University at Albany), Won Sung(BOK)

This paper examines how venture capital alters the impact of banking crises on innovation based on cross-country industry-level data for the period 1980-2012. We exploit the banking crisis as a quasi-experiment for the tightening of bank credit and show several findings. First, the banking crisis causes a lower aggregate rate of innovation for at least five years. Second, the innovation dampening effect of the banking crisis is stronger for industries depending more on external finance. Third, for those industries depending on external finance, the innovation dampening effect of the banking crisis can be mitigated by a more developed venture capital market. Overall, our results highlight that venture capital financing can substitute bank financing for funding innovation during and after banking crises. Our results are robust to the uses of alternative measures of venture capital and external finance dependence, specification, dates of the banking crisis, and post-crisis time window. Finally, the supporting role of venture capital financing for innovation during and after banking crises is stronger for countries with better intellectual property rights and higher political democratization.