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1. Introduction
In this paper, we examine whether access to finance enhances firm innovation. Innovation, which comprises the introduction of new products, process, quality certification, activities, knowledge transfers and technologies, impact on the organisation of a firm’s business activities (Bloch, 2007). Evidence shows that finance affects the innovation abilities of all types of firms, large or small (Benfratello et al., 2008). Access to finance is therefore key to driving innovation. However, the empirical literature is not certain on the direction of the effect of finance on innovation. For example, Ayyagari et al. (2011) and Nanda and Nicholas (2011) find a positive relationship between finance and innovation, whereas Fang et al. (2014) and Cornaggia et al. (2012) show a negative relationship. It is argued that equity finance from pubic markets to fund innovation can be costly to managers because of low tolerance for failure in the public markets (Ferreira et al., 2011).A debt contract might also not be suited to finance innovation that has uncertain returns (Atanassov et al., 2009; Stiglitz, 1985).
Nonetheless, Beck and Demirgüç-Kunt (2006, 2012) show that financially constrained firms find it difficult to engage in innovative pathways. Demirgüç-kunt and Klapper (2012) further emphasise that the ability of firms in Africa to innovate is severely constrained by the lack of access to finance. Kerr and Naranda (2014) also note that the capital structure, and in particular, access to bank finance, plays a key role in innovation outcomes of firms. Equally, although the literature observes the differing impact of capital structure on innovation, it is limited to debt and equity effects and does not give insights into different debt financing instruments and their effect on innovation. For instance, Kerr and Naranda (2014) show the importance of bank finance but they do not articulate the effect of different types of bank finance on innovation. It is therefore clear that one ought to be specific on the type of finance and its effect on innovation. Furthermore, though there is a clear endogeneity between finance and innovation, this is hardly accounted for in the literature. Failure to control for endogeneity can yield bias estimates or produce inconsistent results. Again, the use of R&D expenditure to measure innovation has been heavily criticised in the literature...