Constraints on Innovation Finance in North Jutland, Denmark

Abstract

The paper contributes to an understanding of the nature of financial constraints in a less developed region in Denmark, North Jutland. While based on a general discussion of characteristics of particularly constrained firms, the paper focuses more specifically and empirically on firms' perception of whether there is a financing gap with regard to innovation financing in the region and whether this situation has changed over time. Specifically, the extent to which firms point to financial constraints on their innovation projects and what type of firm sees financing as a constraint. The paper uses a longitudinal study of how a panel of more than 400 firms report financial constraints in six successive surveys. The paper also contributes with a closer linking of innovation and potential financial constraints. The results show that, while lack of external finance is an obstacle to innovation in a relatively small share of firms, the situation worsened in 2002–2004. Financing of innovation is increasingly seen as relatively important and an actual obstacle to innovation. Contrary to expectations, small and/or innovative firms did not differ much in their assessment of financial constraints before 2002. However, size seemed to matter in 2002–2004. Innovative firms were more financially constrained in 2003–2004. Our results indicate both a change in the degree to which financial constraints is a hindrance to innovation and also a change in the specific type of firm with the most severe financing constraint. Therefore one policy implication is that a range of different instruments may be needed if all firms should be targeted with an offer to support innovation activities. Additionally, a prerequisite for policy-makers to react to such changes is a close monitoring of the market development for which an extensive and frequent survey is an important instrument.

Acknowledgements

Comments from participants at the RSA Conference “Regional Growth Agendas” Aalborg, Denmark, 28–31 May 2005, and well-chosen comments on an earlier draft from two anonymous referees are gratefully appreciated.

Notes

1. Tödtling and Trippl (2005) put a similar argument generally on regional innovation policy, claiming that policies have often been copied from successful, high-tech regions and applied to peripheral regions, rendering inexpedient effects. It is argued that innovation barriers are different in different types of regions, therefore policies should be differentiated accordingly.

2. The region has been characterized as peripheral for decades, and is still has characteristics of peripheral regions, such as unemployment rates substantially above country averages and lower incomes. There are, though, signs of a catching-up process in later years.

3. Objective 2 support is a European Commission funded programme for promoting development in peripheral regions.

4. It should be remembered, but is often overlooked, that focusing solely on the firm as the unit of analysis neglects the fact that large firms and high-tech firms often demand larger amounts. Therefore, the financial gap measured by the number of firms rather than in monetary terms, may be underestimating the problems.

5. This contrasts the finding from Rothwell and Dodgson (1994) mentioned earlier. A number of studies point to that the picture of a large firm as being inflexible is overstated. Rather, the fact that such firms often rely on more different products in stead of just one, makes larger firms able to shift quickly among their core products according to the development in the market.

6. In addition to the personality of the entrepreneur, the difference in mentality between managers of small firms and large firms may also hamper possibilities for obtaining finance, because the former tend to view rules and procedures in financial institutions as bureaucratic and slow compared with their own flexible and fast-responding firm. The organization and speed of response in the large firm is more like that of a bank (Storey, 1990, p. 11).

7. More than 90% of capital under management is in this area, but investments are more dispersed. The share of Danish venture capital investments going to firms in North Jutland is below the share of firms in Denmark, whereas funds from a loan guarantee scheme, which is distributed through the (local) banks goes to North Jutland in a proportion corresponding to the share of firms, and in some years even exceeding this share.

8. Maxwell (1990, p. 11) reports studies which show that small businesses in Ireland have to provide collateral in the ratio of 3:1 to cover bank borrowing. The similar figures for the UK are 1.5:1 and for the US 1.2:1. In addition, small firms have to pay an extra interest rate of 3.75%. Other, later studies have found similar results. For Denmark specifically it was found in a survey (Håndværksrådet, 2003) that small firms are treated differently (worse) than large firms and that this is more pronounced in peripheral areas.

9. For example, mortgage institutions in Denmark differentiate the maximum share of the total price of real estate they finance according to postal codes—firms and private persons in urban areas may obtain up to 80% financing, whereas less attractive areas may only be offered up to 60%. Many insurance companies pursue a somewhat similar policy. This imposes additional costs on firms in peripheral areas.

10. Nevertheless, there is currently a lot of research on this issue, as well as evaluation of the practical use of such credit decision systems for small businesses. This applies not only to the credit assessment of the individual firms, notably developed in the credit scoring literature, but also to the previous step, when the firm is recommended which source of finance to approach. See, for example, the toolbox developed by CRESCENDO (2005) and one of EU/Gate2Growth to support regional policy-makers and firms in decisions on regional financing options.

11. While this has a purpose in its own right, it also partly compensates for the fact that, when broken down into sub-catagories, the number of observations in the data set is reduced. If, however, the patterns are stable over time, it will allow us to base our conclusions on a relatively small number of observations.

12. The results and further explanation (in Danish) can be obtained from http://www.business.aau.dk/njk

13. This conclusion is supported by a recent survey on product innovations in the manufacturing industry (Christensen et al., 2004). Thus, 1732 firms were interviewed about potential obstacles to innovation, among other things. Generally, there were few obstacles to innovation, and external finance was only mentioned by a small minority of the respondents.

14. In order to ease comparison, the questions were consistent over time. However, in 2000 there was a minor adjustment with regard to the question on financing. Whereas in 1999 this was put in general terms, from 2000 the question was specifically on external financing. This difference could negatively affect the share of firms assessing this factor as important.

15. Canepe and Stoneman (2003) even find that, in the CIS II and CIS III data, the financial constraint is reported extensively compared with other constraints to innovation. The questions in CIS are phrased a bit differently than in the present survey, since the focus here is more on conditions for innovation.

16. The results can be validated through a comparable survey reported in Christensen et al. (2004). In this survey, 421 North Jutland firms in the manufacturing sector were interviewed about their innovation, R&D, collaboration, etc. When asked about the importance of improved external finance for potential decisions to increase investments in R&D, 4% reported this as having decisive importance and 31% said it had great importance. As the survey was carried out at the beginning of 2004, the comparable year in our survey is 2003. The 3% and 33% in that year corresponds closely to the Christensen et al. (2004) survey.

17. It should be emphasized that the filters for selecting respondents in Figures 2 and 3 means that the number of respondents is reduced drastically. In 2004, the number of respondents with innovation plans (and answering the question on the relative importance of external financing) was reduced from 218 to 77 who assessed problems in obtaining finance. The differences between “yes” and “no”, however, are statistically significant at the 5% level.

18. Statistics for the venture capital market in the past 2–3 years show that there has been a downward trend in the share of new investments relative to follow-on investments, and that the average size of investments has increased. Moreover, the share of investments in the seed phase has decreased relative to start-up and expansion investments (The Danish Growth Fund, 2005).

19. A mid-term evaluation of the programme 2000–2003 (Christensen, 2004) found that around 850 new jobs were created in the 175 subsidized projects, giving average public support per job of DKK 600,000. Additional revenues in these firms were estimated at DKK 8 million per DKK 1 million in public support.