WPS4157


             Firm Innovation in Emerging Markets


Meghana Ayyagari                     Asli Demirgüç-Kunt                  Vojislav Maksimovic*




Abstract: In this paper we investigate the determinants of firm innovation in over 19,000
firms across 47 developing economies. We define the innovation process broadly, to
include not only core innovation such as the introduction of new products and new
technologies, but also other types of activities that promote knowledge transfers and
adapt production processes. We find that more innovative firms are large exporting firms
characterized by private ownership, highly educated managers with mid-level managerial
experience, and access to external finance. By contrast, firms that innovate less are
typically state owned firms without foreign competitors. Identity of the controlling
shareholder seems to be particularly important for core innovation - private firms whose
controlling shareholder is a financial institution are the least innovative. While the use of
external finance is associated with greater innovation by all private firms, it does not
make state owned firms more innovative. Financing from foreign banks is associated
with higher levels of innovation compared to financing from domestic banks.

Keywords: Innovation, Firm Behavior, Financing and Governance

JEL Classification: O31, D21, G32



World Bank Policy Research Working Paper 4157, March 2007

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the
exchange of ideas about development issues. An objective of the series is to get the findings out quickly,
even if the presentations are less than fully polished. The papers carry the names of the authors and should
be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely
those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors,
or the countries they represent. Policy Research Working Papers are available online at
http://econ.worldbank.org.


__________________

*Ayyagari: School of Business, George Washington University, ayyagari@gwu.edu ; Demirgüç-Kunt:
World Bank, ademirguckunt@worldbank.org ; Maksimovic: Robert H. Smith School of Business at the
University of Maryland, vmmaksimovic@rhsmith.umd.edu . The authors would like to thank the National
Science Foundation for support and L. Alan Winters and seminar participants at the World Bank
Microeconomics of Growth conference for useful discussions.

Introduction

        A large literature has shown that financial development has a significant causal

impact on growth. However the channels through which finance operates are not as well

understood. While many economists have taken as given that innovation is one such
channel essential for economic growth and development,1 the finance literature is silent

on how innovation in developing countries is affected by firms' access to finance.

        In this paper, we study the determinants of the rate at which firms across

developing countries innovate and adapt their organizations to meet market conditions.

Most firms in emerging markets are engaged in activities far from the technological

frontier and entrepreneurs innovate not just through original inventions but also by

adopting new means of production, new products and new forms of organization. Hence,

we define the innovation process broadly, to include not only core innovative activities

such as the introduction of new products and new technologies, but also other types of

activities that promote knowledge transfers such as signing joint ventures with foreign

partners or obtaining new licensing agreements, and other actions that adapt the

organization of the firm's business activities such as opening a new plant or outsourcing a

productive activity.

        We first identify the characteristics of innovative firms and then focus on the role

of access to finance, governance, and market competition in influencing firms' ability to

innovate. Specifically, we seek to answer the following questions:

        · Are certain types of firms more innovative than others? What is the impact of

             firm size, age, legal status, and industry sector on the extent of innovative

             activities a firm is involved in?

        · How does access to external finance help innovation? Does access to finance

             disproportionately benefit some firms more than others? How does the source

             of external finance and collateral requirements influence firm innovation?

        · Are state-owned enterprises more or less innovative than other firms? Are

             private enterprises organized as corporations more innovative than other

             private enterprises?

1See, for example, Schumpeter (1934), Baumol (2002) and Aghion and Durlauf (2005) on the importance
of innovation for growth and development. Schumpeter (1934) also highlights the need for thinking about
innovation more broadly than just as inventions.


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        · How does competition, both the number of competitors and the identity of the

            competitor, influence innovation?

        We use a sample of over 19,000 firms in 47 countries, taking measures of firm

innovation from firms' responses to a stratified random survey. The survey also reports

data on each firm's organization and ownership, the type of product market competition it

faces, the educational level of its managers and the amount and sources of external

financing.

        We find that the externally financed proportion of a firm's investment

expenditures is positively related to firm innovation, even after controlling for growth

opportunities. Financing from foreign banks has a much larger impact than financing

from local banks, both in promoting core innovation of introducing new product lines and

technologies as well as other innovative activities related to opening a new plant, and

establishing foreign joint ventures and new licensing agreements. Firms are also more

innovative if a greater share of their borrowing is in a foreign currency.

        Interestingly, we find that state-owned firms are an exception to these findings.

State firms that obtain external financing are not significantly more likely to innovate

(and in some cases, even less likely to innovate) than those state firms that do not obtain

external financing.

        These results do not appear to be driven by reverse causality. We find that there is

a great deal of heterogeneity in the way external finance facilitates firm innovation.

Furthermore, using instrumental variable techniques to deal with the potential

endogeneity of external finance leaves the results unchanged.

        Firm ownership and legal organization are also important determinants of firm

innovation. Privately owned firms are, in general, more innovative than state owned

enterprises and those organized as corporations are more innovative than firms organized

as proprietorships, partnerships or cooperatives. Identity of the controlling shareholder

seems to be particularly important for the introduction of new technology and those

private firms whose controlling shareholder is a financial institution are the least

innovative.

        We also find suggestive evidence for the role of competition in spurring

innovation. Firms are more innovative if the firm is an exporting firm. Foreign



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competition, in particular, has a positive influence on the innovation rates of firms. By

contrast, having a state-owned competitor does not have a significant effect on firm

innovation. We also find evidence that managerial education and experience, and the

education level of the workers are important determinants of firm innovation.

       Our findings are most closely related to two recent papers examining the role of

finance in facilitating innovation and entrepreneurship. Using data on Italian firms,

Benfratello et al. (2006) show that local banking development has a positive effect on the

probability of a firm introducing process or product innovation and this is particularly so

for small firms and for firms in sectors more dependent on external finance. Their paper

however does not examine how access to external finance at the firm level affects

innovation. Gompers et al. (2006) on the other hand, study the supply side of capital.

Using data on venture capital financing of US firms they show that suppliers of capital

have a unique ability to identify the most skilled and successful entrepreneurs. In our

paper we examine if the firms that do get external capital are indeed more innovative than

firms that are not dependent on external finance.

       The rest of the paper is organized as follows. Section 2 presents the motivation

and our hypotheses. Section 3 discusses the data and summary statistics and section 4

presents the empirical model. We discuss our main results in section 5. Section 6

concludes.


2.     Motivation

2.1.   Finance and Innovation

       There is a large empirical literature establishing that financial development
promotes long term economic growth.2 Specifically, at the macro cross-country level,

King and Levine (1993) and Levine, Loayza, and Beck (2000) show that financial

development promotes growth. Cross-country time-series studies by Bekaert, Harvey,

and Lundblad (2001, 2005) also show that financial liberalization boosts economic

growth by improving the allocation of resources and the investment rate. Demirguc-Kunt

and Maksimovic (1998) and Rajan and Zingales (1998) provide evidence at the firm and

industry level showing that reduced access to external finance is associated with lower


2See Levine (2005) for a review.


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growth rates. Beck, Demirguc-Kunt, and Maksimovic (2005) further show that this effect

is especially pronounced for smaller firms.

        However, the channels through which access to finance affects firm growth is not

well understood. Clearly, access to external finance can facilitate capital accumulation.

However, on a macro scale, historians have identified innovation and technological

progress as the principal causes of material progress over extended periods of time (see

for example, Landes (1969), Rosenberg (1982) and Mokyr (1990)). Solow's (1957) path

breaking analysis of growth in labor productivity in the U.S. has established that

technological advances (broadly defined) and skill, rather than capital accumulation are

the prime drivers of increases in labor productivity. Solow (1957) argues that

approximately 80% of the increase in labor productivity in the U.S. over the period 1909-

1949 was due to more productive use of capital and increases in the skill level of the

labor force. More recently, Levine, Loayza, and Beck (2000) have shown that financial

sector development helps economic growth through more efficient resource allocation

rather than through increases in the scale of investment or savings mobilization.

        Given the importance of technological advances for growth, it is important to ask

whether financial development promotes growth by fostering innovation and thus

increasing efficiency. Such an effect would occur if the financial system has an

important role in supplying capital to firms that are innovating or restructuring their

operations in ways that make them more efficient.

        We consider innovation, both narrowly defined as a firm's adoption of new

technology and introduction of new product lines, and a broader definition that takes into

account changes in the firm's operations such as a decision to outsource certain activities
or open a new plant.3 We investigate below whether access to external finance is

associated with greater firm innovation whereby firms adapt their operations at a higher
rate.4




3In the next section, we define the activities we analyze more precisely.
4Using UK data, Aghion, Bond, Klemm, and Marinescu (2004) find that firms that report R&D activity are
financed differently than firms that do not report any R&D activity.


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2.2.     Firm Governance and Innovation

         A large literature in finance has linked firm governance to firm value, share price
and profitability.5 However, none of these papers have explored the role of firm

governance in promoting innovation. We explore how four aspects of firm governance

relate to innovation. First, we examine whether innovation rates differ between private

businesses and state enterprises, two ownership structures with very different incentive

mechanisms. The work of Shleifer (1998) and La Porta, Lopez-de-Silanes, and Shleifer

(2002) on the performance differences between state and privately owned firms, suggests

that the rate of innovation should be significantly higher in private businesses.

         Second, we examine whether the organizational form of private businesses affects

their innovation. Demirguc-Kunt, Love, and Maksimovic's (2006) investigation of the

incorporation decision suggests that corporations become more prevalent and have

comparatively higher growth rates in better institutional environments. However, we do

not know if the differences in organizational forms, with their concomitant differences in

governance, affect the rate of innovation.

         Third, we also examine if the identity of the controlling shareholder of a private

business affects its innovation. Recent work by Raphael and Villalonga (2006) suggests

that family controlled firms may be systematically different from other businesses.

Family ownership is likely to be particularly important in developing countries where the

protection of minority shareholders is limited. Hence, we investigate whether the identity

of the controlling shareholder is correlated with the rate of innovation.

         Fourth, we examine how educational attainment, prior work experience, and

tenure of the firm's top management relate to the rate of innovation. A negative relation

between tenure in top management and firm innovation might suggest managerial

entrenchment and be indicative of governance or contracting problems which prevent

efficient turnover.




5The studies linking governance to firm performance include Black (2001), Black, Jang and Kim (2006),
Durnev and Kim (2005), Klapper and Love (2004), Gompers, Ishii and Metrick (2003), Lang, Lins, and
Miller (2003), and Doidge, Karolyi, and Stulz (2004). Most of these studies are based on large firms and do
not include small and medium firms that dominate our study.


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2.3.    Competition and Innovation

        We also examine the relation between firm innovation and the intensity of

competition in the product market. The effect of the product market on firm innovation is

of particular policy interest, since it is likely to be easier to control the amount of

competition and the openness of the product market to foreign competition, than to

reform a country's legal and financial institutions. Some support for this view is provided

by Blundell, Griffith, and Van Reenan (1995), who find that in developed economies, as

concentration and monopoly power increases, the rate of innovation falls. Nickell (1996)

and Nickell, Nicolitsas, and Dryden (1997) find an inverse relation between growth in

productivity and industry concentration. More recently, Aghion et al. (2006) have shown

that intensity of competition, as measured by entry into an industry, affects efficient and

inefficient incumbent firms differently. Entry spurs innovation among the more

technologically advanced incumbent firms and slows it among the less efficient

incumbents.

        We measure the number of competitors a firm faces, their relative technological

sophistication, and the quality of competition. In our sample, firm organization and

governance are likely to be important predictors of efficiency. Thus, we track domestic

private competitors, foreign competitors (who, in our developing country sample, are

likely to be more sophisticated) and competitors who are state enterprises. The latter are

likely to be poor competitors based on the findings of earlier literature.

        Of particular interest is the effect of the interaction between the firm's

organizational structure and the level of competition on the rate of innovation. Allen and

Gale (2000) argue that for most firms in developing countries, the relevant disciplining
device for controlling agency costs is the intensity of competition in the product market.6

As the intensity of competition increases, a firm's freedom to deviate from efficient

investment and innovation policies declines. A counter argument would suggest that as

the level of competition increases, the firm's ability to enter into beneficial implicit

contracts with customers and suppliers may decrease because the value of maintaining a




6See also Scharfstein (1988), Alchian (1950), Stigler (1958) and Hart (1983).


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reputation also decreases.7 Below, we explore the relation between competition,

governance, and firm innovation.

         Finally, we also consider the relation between firm size and innovation. Since

Schumpeter (1947), there exists a large literature relating the rate of innovation to firm
size in developed economies.8 Below, we explore differences in the rate of innovation

across firm size categories in our sample of developing country firms. We also treat firm

size as a control variable in our tests of the relation between financial access and

governance and the rate of innovation.

         In summary, the literature on firm growth and financial development suggests that

innovation is likely to be an important channel through which financial development

affects growth. Below we test this hypothesis by examining the relationship between

firm innovation and external financing, firm governance and product market competition.

In our sample, the governance factors that are likely to be important are ownership

structure and differences in legal organization, and their interaction with product market

competition.


3.       Data and Summary Statistics

         The World Bank Investment Climate Survey database (ICS) consists of firm
survey responses of over 19,000 firms in 47 developing countries.9 The core survey uses

standardized survey instruments and a uniform sampling methodology to benchmark the

investment climate of individual economies across the world and to conduct firm

performance analyses. The survey also report detailed information on firm employment,

age, industry, ownership, legal status, and the number of establishments. The Investment

Climate Survey sample from the universe of registered businesses and follow a stratified

random sampling methodology.           10




7See, for example, Maksimovic (1988) or Maksimovic and Titman (1991).
8According to Schumpeter, large firm size is essential for innovation since larger firms can provide
economies of scale in production and innovation. Other studies, by contrast, have emphasized the role of
small firms including Rothwell and Dodgson, 1994; Acs and Audretsch (1987); and Scherer (1965) to
name a few.
9The survey actually covers 44,000 firms in 67 countries. The sample is reduced to 19813 firms in 47
countries after eliminating observations with missing firm-level innovation variables.
10A detailed description of the sample design and sample frame can be found at
http://www.enterprisesurveys.org/documents/Sampling_Note.pdf and a detailed description of the


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         A great advantage of this survey is its broad coverage of the extent of innovation

that the firms undertake. Previously, there has been very little consistent data across

countries on the nature of innovative activities undertaken by firms. Moreover, the

available data typically covers only the developed countries and focuses on patents and

R&D expenditures. However, the issues are likely to be different for most developing

countries where imitation and adaptation of already-created and tested innovations, rather

than cutting-edge innovations, are likely to be more important. Thus, in studying

innovation in developing countries, it is all the more important to define innovation

broadly rather than just as new inventions.

         The new investment climate surveys allow us to capture the rate of firm

innovation in this broader sense. Specifically, the surveys ask firms if they have

undertaken any of the following ten innovative activities in the last three years:

Developed a major new product line, Upgraded an existing product line, Introduced new

technology that has substantially changed the way that the main product is produced,

Discontinued at least one product (not production) line, Opened a new plant, Closed at

least one existing plant or outlet, Agreed to a new joint venture with a foreign partner,

Obtained a new licensing agreement, Outsourced a major production activity that was

previously conducted in-house, and Brought in-house a major production activity that

was previously outsourced. The firm responses are coded as 0-1 (No-Yes) dummy

variables for each of the 10 questions.

         In addition to the ten individual indicators of firm innovation, we analyze three

aggregate indicators for each firm as reported in panel B of Table 1. Our approach

parallels La Porta et al's (1998) use of indices that aggregate individual characteristics in

the study of corporate governance. INDEX8 is an aggregate index obtained by summing

the number of activities in which the firm engages, excluding two of the activities,
Discontinued at least one product line and Closed at least one existing plant or outlet.11

These activities are left out of INDEX8 because they are less likely to require outside

financing than activities such as the introduction of new technology or the opening of a


implementation can be found at
http://www.enterprisesurveys.org/documents/Implementation_note_January_2007.pdf
11We also experimented with an aggregate indicator of the ten individual indicators of innovation as well
as a principal component indicator of the ten individual indicators of innovation and found our results to be
consistent with the aggregate index, INDEX8.


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plant. They are instead represented in INDEX2 which is obtained by summing firm

responses to the two activities, Discontinued at least one product line and Closed at least

one existing plant or outlet. CORE is an aggregate index obtained by summing firm

responses to two activities, Developed a major new product line, and Introduced new

technology that has substantially changed the way that the main product is produced, to
reflect the narrow definition of core innovation as used in existing literature.12

        In addition to the rich detail on the innovative activities undertaken by firms, the

survey has information on firm size, age, legal organization, number of establishments

and capacity utilization, all of which are used as firm level controls in our study. The

survey defines firms of different sizes, small, medium and large firms, on the basis of the
number of full time workers.13 Small firms are defined as those with less than 20

employees, medium firms employ 20 to 99 employees, and the large firms employ 100 or

more employees. The sample is largely dominated by small and medium sized firms.

Small firms make up 37% of the sample, medium firms constitute 35%, and large firms

constitute 28% of the overall sample. Thus, the survey provides data across a much

broader cross-section of firm sizes than is available in commercial data bases, such as

Worldscope.

        Table 1 summarizes the proportion of firms in each country that undertook each

of the ten innovative activities over the year prior to the survey. All the countries in the

sample are developing economies with GDP per capita in 2000 ranging from 192 U.S.

dollars in the case of Tanzania to 11,646 U.S. dollars in the case of Slovenia.

        The countries in the sample show a great deal of variation across the ten different

categories of firm innovation. Firms in any country are more likely to undertake only

certain types of innovative activities than others and hence in no single country are firms

uniformly less or more innovative across the 10 different categories. Nevertheless, the

aggregate indices, INDEX8 and CORE2, suggest that firms from Cambodia, Brazil, and

South Africa are the most innovative, while firms from Egypt, Oman, and Turkey are the

12In unreported regressions we also analyzed a core innovation index which includes upgrading an existing
product line. While the results were unchanged in majority of the specifications, we prefer to leave this
index out of the core innovation index as it may overestimate the extent of innovation, since even very
minor changes may qualify as upgrades.
13Employment is typically the most reliable figure in developing countries. Hence, number of full time
workers is used as a measure of firm size by the World Bank Group and other international survey teams
including RPED and the Oxford Centre for the Study of African Economies.


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least innovative. For instance, 68% of Brazilian firms introduced a new product line,

95% upgraded an existing product line and another 68% introduced a new technology

compared to Egyptian firms that were the least active in each of these categories (with

corresponding numbers of 15%, 23% and 11% respectively). However, it is important to

note that Brazilian firms are not innovative across all categories. Only 4% of Brazilian

firms sign joint ventures and only 7% enter into new licensing agreements (the numbers

for Egypt, Oman, and Turkey are similar) compared to 23% of firms in Belarus that sign

new joint ventures and 38% of Russian firms that enter into new licensing agreements.

        When we look at the numbers across different firm size groups, we find that

larger firms are more innovative across all activities compared to smaller firms. The

aggregate indicators also reveal that larger firms are more innovative than smaller firms.

        Table 2 contains the sample statistics of the variables we consider. It shows that

across countries, a higher percentage of firms are more actively engaged in core

innovation (42% introduced new product lines and 39% introduced new technology) than

in other types of innovative activities (for instance, only 7% signed joint ventures). The

aggregate indicator, INDEX8, shows that firms on average undertake around two out of

eight activities.

        The firms in the survey are broadly classified in terms of legal organization into

corporations; cooperatives, sole proprietorships and partnerships; and all other forms.

Corporation is a legal status dummy that takes the value one if the firm is organized as a

Corporation and 0 if the firm is organized as a Cooperative, Sole Proprietorship or

Partnership or has some other form. Panel A of Table 2 shows that 43% of the sample is

composed of corporations. The average firm age in the sample is 16 years. The survey

also asks firms to report the number of separate operating facilities or establishments.

While most firms are single establishment firms (73%), the mean number of separate

operating facilities is about two establishments per firm.

        The growth opportunities available to a firm may be an important determinant of

the extent and type of innovative activities a firm is engaged in. Since we do not have a

direct measure of a firm's growth opportunities, we use firms' capacity utilization rates as

a proxy for growth opportunities of the firm. In the survey, capacity utilization is defined

as the amount of output actually produced relative to the maximum amount that could be



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produced with the firm's existing machinery, equipment and regular shifts. We include

dummy variables to identify firms that have low growth opportunities (capacity

utilizations below 50%), medium level of growth opportunities (capacity utilization

between 50 and 80%) and firms with high growth opportunities (capacity utilization rates

in excess of 80%). The variable Capacity Utilization takes on values 1 to 3 corresponding

to the three categories just identified. When we look at the individual capacity utilization

dummies (summary statistics not reported in the table), we find that more than 50% of the

firms in the sample have high capacity utilization rates, indicating high growth

opportunities.

        Panel B of Table 2 presents the correlations between the different innovation

indicators and Panel C presents the correlations between the aggregate innovation

indicators and firm level variables. Panel B shows that all aspects of firm innovation are

highly correlated at the 1% level. The correlation coefficients range from 0.03 to about

0.46. The highest correlation coefficient of 0.46 indicates that firms that introduce a new

product line are also highly likely to upgrade an existing product line. Panel C of Table 2

shows that the aggregate indicators CORE2 and INDEX8 are very highly correlated with

each other, with a correlation coefficient of 0.81 and are also significantly correlated with

INDEX2 and all other firm variables. However, given the correlations among different

firm characteristics, we investigate these relations in the next section through regression

analysis.


4.      Determinants of Firm Innovation: The Empirical Model

        To study determinants of firm innovation we proceed in two steps. First, we

analyze innovative activities controlling for broad firm characteristics, such as size, age,

legal status, number of establishments, industry and capacity utilization. We also control

for the GDP/Capita of the country. Next, we introduce variables that enable us to

examine the relationships between innovation and firm financing, governance, and

competition environment. We do not include all variables at once so as to not overload

the specification and to avoid reducing the sample size significantly since some of these

variables are available for only a subset of observations.




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         In the first step, the regression equations we estimate are of the form:

Firm Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4

Corporation Dummy +5 Number of Establishments + 6 Capacity Utilization Dummies

+ 7 Industry Dummies + 8 Country Dummies +                                                              (1)
         All regressions are estimated using firm level data across 47 countries.14 The

dependent variable is either one of the three aggregate indicators (INDEX8, CORE, or

INDEX2), or one of the ten underlying indicators of innovation based on firms' responses

to survey questions. Since the ten individual indicators of firm innovation are 0-1

variables, these regressions are estimated using a Logit probability model. For the

aggregate indicators, we use Ordered Logit. All regressions report robust standard errors.

         We use equation (1) as the baseline and build on it to examine the impact of

governance (i.e. competition, ownership, management) and access to external finance. In

the second step the regression equations we estimate are of the form:

Firm Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4

Corporation Dummy +5 Number of Establishments + 6 Capacity Utilization Dummies

+ 7 Industry Dummies + 8 Country Dummies + 9 X +                                                        (2)

where X is a variable or a vector of variables characterizing different aspects of the firm's

financing, governance, and competition environment.


5.       Results

         Table 3 reports the estimated coefficients of baseline regression (1). The table

shows that individual firm characteristics are an important determinant of the extent of

innovation a firm undertakes. Probability of undertaking all types of innovative activities

increases with firm size. Compared to small firms, medium and large firms are more

likely to develop new product lines, upgrade existing product lines, introduce new

technology, discontinue at least one product, open a new plant, close at least one existing

plant, sign a new joint venture with a foreign partner, sign new licensing agreements,

outsource a major activity and bring in-house a previously outsourced activity. The F-test


14We prefer to include country dummies in the regression specification rather than clustering since
clustering would assume the country effect to be a part of the composite error term and thus uncorrelated
with the other regressors. However, we find that the amount of external financing varies significantly
across countries necessitating the use of country dummies.


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reported in Table 3 suggests that the differences between medium and large firms are

significant. Larger firms are also more innovative when we look at the aggregate

indicators. The marginal effects (not shown in the table) calculated for the most

innovative (CORE=2) firms show that the probability of core innovation increases by

16% for large firms compared to smaller firms.             15


         The number of establishments increases the probability that a firm will open or

close a plant, as expected. Firms with a larger number of establishments are also more

likely to sign new joint ventures and outsource a major activity and are more innovative

based on the aggregate indicators as well.

         Controlling for size and the number of establishments, firms organized as

corporations also report more innovative activity than other businesses. The marginal

effects show that the probability of core innovation increases by 3.7% for incorporated
firms compared to cooperatives, sole proprietorships or partnerships.16 Being

incorporated has no effect on plant opening and closing decisions, although it increases

the probability of all other activities.

         Looking at the aggregate indicators, we also find evidence that younger firms and

firms with higher growth opportunities are more innovative. These effects are also

economically significant. For instance, the marginal effects of Core Innovation with

respect to capacity utilization and age reveal that with a unit change in growth

opportunities (high capacity utilization), the probability of core innovation increases by

7.5% and with a unit change in age, the probability of core innovation decreases by -

0.08%.

         The underlying innovation indicators suggest more diversity. For instance,

younger firms are more likely to introduce new products and new technology, upgrade

existing product lines, open a new plant, sign joint ventures, and bring in previously out-

sourced activities, but older firms are more likely to discontinue products or close


15The marginal effects are computed at the mean of the other independent variables and are not reported in
the tables. Throughout the paper, discussion of marginal effects refers to the case where marginal effects
are computed for Core Innovation=2.
16Since the model is nonlinear, the value of predicted probabilities depends on the values of all other
control variables. The economic effects reported are evaluated at the mean value of the control variables.
However, even when we estimate the predicted probabilities for corporates and non-corporates for the full
distribution of the control values, we see that the corporations have consistently higher predicted
probabilities of innovation than un-incorporated firms.


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existing plants. Growth opportunities do not affect a firm's out-sourcing/in-sourcing

decisions or likelihood of opening a new plant or signing new licensing agreements. On

the other hand, firms with high growth opportunities are less likely to discontinue

products and close plants.

        All industries are not equally innovative as suggested by the F-tests reported at

the foot of the table. Although not reported in the table, our results indicate that of the 26

industries that the firms in our sample belong to, those in electronics, metals and

machinery, chemicals and pharmaceuticals, telecommunications, auto and auto

components, and other manufacturing are the most innovative in this sample of countries.

        Table 3 also shows that for this sample of countries, there is contrasting evidence

on the effect of average GDP/Capita of the country on core innovation versus the other

types of innovative activities a firm undertakes. The coefficient of Log GDP/Capita is

negative and significant only in the case of firms introducing new product lines, but is

positive and significant for firm discontinuing products, opening and closing plants,

signing joint ventures and licensing agreements and outsourcing production activities.


5.1.    External Financing and Innovation

        In this section, we examine whether the availability of external finance affects the

extent of innovation that a firm undertakes. In the Investment Climate Assessments

surveys, enterprise managers were asked: "Please identify the contribution over the last

year of each of the following sources of financing for your establishment's new

investments that includes new land, buildings, machinery and equipment." The sources

are internal funds or retained earnings, local commercial banks (loan, overdraft), foreign

owned commercial banks, leasing arrangement, investment funds, trade credit, credit

cards, equity, funds from family and friends, informal sources, such as moneylenders, and

other sources. The sum of these proportions adds up to one hundred percent. The survey

also asks firms if they have a bank loan and the year in which the financing was approved.

Hence we construct a Bank Loan dummy which takes the value 1 if the firm had been

approved for a bank loan in 2001 or earlier and 0 if the firm did not have a bank loan

approved prior to 2002. The Bank Loan dummy measures past access to external

financing.



                                                                                            15

       We also examine the impact of the share of borrowing in foreign currency and the

necessity of collateral. The share of borrowing in foreign currency is the borrowing

denominated in foreign currency as a share of total borrowing. The necessity of collateral

is a dummy variable that takes the value one if financing requires collateral or a deposit,

and zero otherwise.

       The results in Table 4 show that there exists a significant positive relation

between the use of external finance and the extent of firm innovation. In particular,

external financing from foreign banks, leasing, investment funds and trade credit are

significantly positively related (at the 1% level) to the aggregate innovation indices,

INDEX8 and CORE. The underlying indicators reveal that foreign bank financing is

important for all types of innovative activities except discontinuing products, closing

plants and sourcing agreements. On the other hand, trade credit financing is particularly

important for sourcing arrangements. The F-tests testing the difference between local and

foreign banks show that financing from foreign banks is associated with significantly

higher rates of innovation compared to financing from local domestic banks especially in

the case of introducing new technology, opening new plants and signing new joint

ventures. This difference is also significant for the aggregate index, INDEX8. When we

examine the effect of access to bank financing in the past on innovation, we find that the

Bank Loan dummy coefficient is positive and significant for all the aggregate indices.

       We also find that firm innovation increases with greater share of borrowing in

foreign currency. Demirguc-Kunt and Maksimovic (1998), Rajan and Zingales (1998)

and Beck, Demirguc-Kunt, and Maksimovic (2005) show that access to external finance

is associated with higher firm growth rates. These papers do not specify the channels by

which access to finance affects firm growth. Our results show that in developing

economies access to external financing and, in particular, foreign financing, is associated

with a higher rate of innovation.


5.2    Governance and Innovation: The Impact of Ownership, Competition, and

Management

       In this section, we examine the impact a firm's governance structure has on its

innovation. First, we look at the impact of firm ownership, whether it is private or state-



                                                                                         16

owned; and for private firms, the impact of the identity of the controlling shareholder.

Second, we analyze the firms' competition environment. And finally, we investigate the

impact of human capital, i.e. the education and experience level of firm managers, as well

as that of workers.

          Ownership Structure: The role of private versus public ownership has been a

much researched area in finance and has been particularly relevant in developing

countries, many of which opted for state ownership of the "strategic" sectors as a way of

achieving their development goals. However, there has been little empirical evidence on

the impact of public versus private ownership on firm innovation. In this section we

examine if being a private owned firm versus a state owned firm, or a domestic versus a

foreign owned firm has any impact on firm innovation. State (Domestic) ownership is a

dummy variable that takes the value 1 if the state (domestic private sector) owns 50% or

more of the company and 0 otherwise.

          We also break down domestic private ownership into the following seven

categories - Individual, Family, Financial Institution, Managers, Employees, Domestic

Corporation and Others. These are dummy variables that take the value 1 if the largest

shareholder or owner in the firm is an individual, family, financial institution, manager of

the firm, employee of the firm, domestic company, or someone other than one of these
categories including the government or government agencies.17 Recent evidence in

finance on the role of family firms has been mixed. Several papers posit that family

owned and managed firms are better able to mitigate owner-manager agency problems

and hence are more valuable (eg: Palia and Ravid (2002), Adams, et al. (2004),

Fahlenbrach (2004)) and that founders bring valuable skills to the firm (Morck et al.

(2000)). Burkart, Panunzi, and Shleifer (2003) however argue that hired professionals

may be better managers than family founders or their heirs and the decision to cede

control to professional management depends on the investor protection environment. In

more recent work, Raphael and Villalonga (2006) show that whether family firms are

more valuable or not depends closely on management (eg: Founder-CEO or Founder

17In our sample construction for the regressions, we first test state owned firms against all other private
sector firms (both domestic and foreign). For our regressions with the domestic dummy, we drop all firms
with greater than 50% state ownership and test domestic versus foreign ownership. Finally, we drop all
firms with greater than 50% foreign ownership and investigate how the identity of the firm owner impacts
innovation in a sample of domestic private sector firms.


                                                                                                           17

Chairman with outside CEO) and the presence/absence of control enhancing features.

While we don't have data on management and controlling structures in family firms, we

are able to separately study the importance of both family firms and management skills

on innovation.

        We find that state ownership has a negative impact on overall firm innovation.

State owned firms are less likely to introduce new products, upgrade existing products,

introduce new technology, open new plants, or sign new joint ventures or licensing

agreements than privately owned firms. When we compare domestic versus foreign

ownership, we see that domestic firms are more likely to close existing plants or bring in-

house previously outsourced activities whereas foreign ownership increases the

probability that a firm will sign new joint ventures with foreign partners and new

licensing agreements.

        Next, we investigate whether the actual identity of the domestic private

controlling shareholder makes a difference for firm innovation. At the 1% and 5%

significance level, identity of the controlling shareholder seems to be particularly

important for introduction of new products, new technology, discontinuing products,

opening new plants, and signing joint ventures and licensing agreements. Private firms

whose controlling shareholder is a financial institution tend to be less innovative in

particular. This is of interest since firms owned by financial institutions presumably have

easier access to finance, yet are less innovative, suggesting that when finance is not

provided on market criteria, the effect can be counter-productive. We also find that

employee owned firms and firms owned by domestic corporations are more likely to

discontinue products.

        When we look at the aggregate indicators of firm innovation, we find that if the

controlling shareholder is an individual or a family or the manager of the firm, firms are

more innovative than if the largest shareholder is the government. Firms owned by a

financial institution or investment fund are particularly less innovative than other types of

ownership structures. This is consistent with La Porta, Lopez-de-Silanes and Zamarripa

(2003) who find that related loans, where banks lend to firms controlled by the bank's

owners, are not necessarily to the best firms. They find that 33% of related loans are more

likely to default and have lower recovery rates than unrelated loans. Looking at the



                                                                                          18

aggregate innovation indices, CORE and INDEX8, the F-test rejects that all coefficients

are equal to each other.

        Competition: We use seven variables to study different aspects of firm

competition: Number of competitors; Percentage of sales sold domestically, that helps

identify whether a firm is an exporter or not; Firm's technology compared to competitor,

that takes values 1, 2 or 3 depending on whether the technology is less advanced, about

the same or more advanced than that of its main competitor; Does the firm have a foreign

competitor is a dummy variable that takes the value 1 if the firm has one or more foreign

firms as a competitor; Does the firm have a state competitor is a dummy variable that

takes the value 1 if the firm has one or more state owned enterprises as a competitor and

0 if the firm has no state competitors; Foreign Competition has greatest influence to

reduce production costs is a dummy variable that takes the value 1 if foreign competition

had the greatest influence to reduce production costs and takes the value 0 if the greatest

influence was from domestic competition, customers, creditors, shareholders or the

government instead; and Foreign Competition had greatest influence to develop new

products is a dummy variable that takes the value 1 if foreign competition was the most

important influence on the firm to develop new products and takes the value 0 if the

greatest influence was from domestic competition, customers, creditors, shareholders or

government instead.

        The results in Table 6 suggest that the higher the number of competitors, the more

likely that the firm will bring in house previously outsourced activities, and less likely

that the firm will open new plants or enter into new licensing agreements. There is also

some evidence that higher the number of competitors, the firm is also more likely to

engage in core innovation though these results are not statistically significant. Firms with

a greater percentage of their sales sold domestically rather than exported are overall not

as innovative as exporting firms, suggesting that non-exporters face lesser competitive

pressures than exporting firms. Exporters are more likely to upgrade product lines,

introduce new technology, open new plants and enter into joint ventures or licensing

agreements. If the firm's technology is better than that of its competitor, the firm is more

likely to engage in all types of innovative activities except discontinuing product lines

and closing plants.



                                                                                          19

        Table 6 also shows that the identity of the competitor can be important.18 Facing

competition pressures from a foreign owned firm is beneficial for all types of innovative

activities except opening plants and signing new licensing agreements. The aggregate

indicators, CORE and INDEX8 are also positive and significant indicating the positive

influence of foreign competition on core innovation. Interestingly, having one or more

state owned firms as a competitor has no significant effect on the aggregate indicators of

firm innovation. When we look at the individual indicators, a firm is less likely to

discontinue products if it faces state competition.
        Given the positive influence of foreign competition,19 we further investigate if the

influence of foreign competition works through its impact on firms' decisions to develop

new products or reduce production costs. Firms reporting that foreign competition had

the greatest influence to reduce their production costs were more likely to introduce new

products, open new plants, sign new joint ventures and licensing agreements. Firms

reporting that foreign competition had the greatest influence to develop new products

were most likely to sign new joint ventures with foreign partners. Interestingly,

differentiation strategies rather than cost reduction strategies had a greater impact on firm

sourcing decisions.

        Managerial Education and Experience - Impact of Human Capital: Next, we

examine if a firm's human capital has an important influence on innovation capability.

Human capital, as measured by the education and experience level of the management

and workforce, has been shown to have an important influence on firm investment

decisions and overall firm behavior. In this section we examine the influence of human

capital on a firm's rate of innovation. We specifically look at the education and

experience level of the top manager and the workforce.

        The variables are defined as follows: Top Manager's Total Years of Experience is

the total number of years of experience the top manager has had working in this sector,

before running the establishment; Mid-Level Experience is a dummy variable that takes

the value 1 if the top manager has had between 3-10 years of experience working in this

18The variables capturing the identity of the competitor (foreign or state) and the influence of foreign
competition are available for a much smaller sample of firms. Sample sizes in these regressions range from
4300-4900 firms.
19In unreported regressions, we also find that percentage of foreign competition has an impact on the
aggregate indicators.


                                                                                                         20

sector before running the establishment; Highly experienced is a dummy variable that

takes the value 1 if the top manager has had more than 10 years of experience working in

this sector before running the establishment; Skilled Foreign workers is the percentage of

permanent skilled workers that are foreign nationals; Percentage of workforce that has

more than 12 years of education summarizes the percentage of workforce with formal

university level education of 12 years or more; and Highest education level of the

manager takes values 1 to 6 according to the following categories-did not complete

secondary school, completed secondary school, vocational training, some university

training, graduate degree and post graduate degree.

         We find that the number of years of prior experience the top manager has had in

the same industry has no effect on whether the firm is likely to be innovative or not. On

investigating deeper, we find that firms run by managers with three to ten years of

experience are more innovative than firms run by inexperienced managers. Specifically

these firms are more likely to introduce new product lines, upgrade existing product lines,

introduce new technology and sign new licensing agreements. Managerial experience of

more than 10 years seems to be important mainly in the case of bringing in-house

previously outsourced activities.

         When we look at the importance of skill we find some evidence that foreign

skilled workers are an asset when it comes to signing a new joint venture with a foreign

partner. The education level of both the manager and the workforce, have a significant

influence on the extent of innovation a firm undertakes. We find that firms with

workforce with greater than twelve years of education are more innovative along most

dimensions, except with respect to opening and closing plants and bringing in-house

previously outsourced activities. However, having a highly educated manager makes a
firm more innovative along all dimensions.20 These results support the importance of

human capital as measured by education and experience level of managers and workers

for firm innovation.




20On the education question, firms were asked to report what percent of workforce had the following
education levels: Less than 6 years ("some elementary"), 6-9 years, 10-12 years, More than 12 years (some
university) with the four values summing to a 100%. Dropping firms that had values greater than or less
than 100 did not change any of the results.


                                                                                                       21

5.3.    External Financing, Competition, and Innovation-Robustness

5.3.1. External Financing and Innovation

        The results in Table 4 suggest a strong correlation between firm innovation and

external finance. While this may indicate that the availability of external finance spurs

firm innovation, it could also suggest reverse causality. Firms that innovate and therefore

have better growth opportunities may also be the ones that are able to raise external

finance and introduce new technologies and products.

        To control for reverse causation, we control for growth opportunities in our

regressions by including a variable "capacity utilization" at the firm level. Even after

controlling for growth opportunities, firm size (employees and number of establishments),

age, industry and legal organization, external financing is strongly related to firms'

probability to undertake core innovation, and other innovative activities. In addition, we

find that access to bank financing in years before the survey (prior to 2002) also has a

positive and significant impact on firm innovation suggesting that our results are not

driven by reverse causality. Nevertheless, in this section we probe deeper into the

relationship between firm innovation and external finance. First, we estimate

instrumental variable regressions to deal with reverse causality more formally and second,

we investigate if external finance affects all firms' innovation rates in the same way.

        In Panel A of Table 8, we use two stage instrumental variable (IV) regressions to

deal with the potential endogeneity. The regressions control for baseline firm

characteristics and the instrumented external finance variable. In the first stage we use

three sets of instruments for external finance. First, we use historical variables

commonly used in the literature, namely Latitude of a country's capital city, the country's

Legal Origin, Religion, and Ethnic Diversity. These are found to be highly correlated
with the development of financial systems around the world.21 Second, since our analysis

is at the firm level as opposed to pure cross-country, we also use external financing

averaged within each country. While innovation at an individual firm may lead to greater

external finance for that firm, it is not likely that it would explain the average level of

external financing in that country. All instruments are significantly correlated with firm



21See Beck, Demirguc-Kunt, and Levine (2003) and Ayyagari, Demirguc-Kunt, and Maksimovic (2006,
2007) for a discussion of these different instruments.


                                                                                               22

level external finance. Finally, we use historical instruments again but do all the analysis

at the country level. The aggregate innovation indicators (dependent variables) and

external financing (independent variable) are averaged across countries. In the last

specification, since we are performing the analysis at the country level, we only control

for Log GDP/capita and do not control for any of the firm level variables (age, firm size,

number of establishments, capacity utilization, industry or legal form).

        Since the IV approach is applicable only to linear models, in panel B, we also

report two stage regressions. In the first stage, ordinary least squares regressions are used

to predict external financing. In the second stage, to investigate the impact of the

predicted value of external financing on innovation, we use ordered logit regressions.

        Panel A shows that the coefficient of the instrumented external financing variable

is positive and significant in the CORE and INDEX8 regressions, suggesting that reverse

causality is not the main driver of our findings. External financing does not have an effect

on discontinuing products or closing plants as shown in the INDEX2 regressions. These

results are reinforced when we look at the two stage results in Panel B. The predicted

value of external financing from first stage regressions has a positive and significant

impact on core innovation.

        Next, we explore if access to external finance benefits all firms universally by

interacting external finance with firm size, age, ownership and organizational form in

Table 9. Table 9 shows that while the availability of external finance makes firms more

likely to innovate regardless of age and legal organizational form, ownership does matter.

We have some evidence that state firms are likely to innovate less with external finance

(see INDEX8) compared to private firms. Foreign firms, on the other hand, are likely to

innovate more with external finance compared to private domestic firms, particularly by

introducing new technology and through obtaining new licensing agreements. The

aggregate innovation indices also indicate that foreign firms are more innovative with

external financing.

        There is some evidence that large enterprises are more likely to introduce new

technology and sign new licensing agreements with greater access to external finance.




                                                                                           23

External financing doesn't seem to particularly help innovation in small and medium
enterprises.22

          However, it could be that we are unable to capture the differences by treating

firms of different sizes together in the same regression. Small sample sizes prevent us

from running separate regressions for each size group. Hence, to further analyze the link

between firm size and innovation, in Figure 1, we compute the average sources of

external financing used by different firms. We sub-categorize the firm sizes into Small0,

Small1, Small2, Medium0, Medium1, Medium2, Large0, Large1, and Large2 to reflect

the extent of core innovation the firms undertake. For instance, Small0 reflects small

firms that undertake no core innovation, Small1 reflects firms that undertake take at least

one core innovative activity (i.e. introduce new products or introduce new technology)

and Small2 reflects firms that undertake both types of core innovation.

          Figure 1 shows that both small and large firms that innovate (Small2 and Large2

respectively) use a greater amount of external financing (or lesser amount of internal

financing) than small and large firms that do not innovate (Small0 and Large0

respectively). This pattern is particularly pronounced for small firms. Several other

interesting patterns are revealed in the types of financing that firms use. On comparing

just the innovators, Small2, Medium2 and Large2, we find that small firms that innovate

rely mostly on financing from family and friends for their external financing needs where

as medium and large firms rely mainly on bank financing.

          Together, Table 9 and Figure 1 suggest that there is more than simple reverse

causality since not all firms that receive external finance are equally innovative. Thus,

although external finance is important in enabling firms to implement innovations, some
firms are better able to make use of this financing.23


5.3.2. Competition and Innovation

          In this section we investigate if there are non-linearities in the impact of

competition and external financing on innovation. Recent work by Aghion et al. (2006)

22In unreported regressions, we find that the interaction term of external financing and a small firm dummy
is significant at the 1% level for bringing in-house previously outsourced activities.
23In unreported regressions we have also investigated whether availability of finance affects all industries
equally. Again there are differences, with IT Services, Metals and Machinery, and Mining and Quarrying
industries innovating more with greater external finance.


                                                                                                           24

predicts an inverted U relationship between competition and innovation, in the sense that,

innovation initially increases with an increase in product market competition and then

declines. The inverted U relationship is particularly applicable to core innovation in

countries and industries that are at the forefront of the technology frontier.

        In our sample of emerging markets, where innovation is mainly through

adaptation or imitation, we examine if there are non-linearities in the relation between

competition and innovation by interacting with firm characteristics. We are particularly

interested in the interaction between firm organization and competition on innovation.

While we used seven indicators of competition in Table 6, in this section, we restrict

ourselves to the variable which is available for the largest sample of firms - Percentage of

establishment sales that are sold domestically.

        In Table 10, we present interaction regressions with the full set of control

variables. The aggregate indicators in Table 10 show that while there is an inverse

relationship between the percentage of establishment sales sold domestically and the

extent of innovation, this is less likely when the firm is a corporation and more likely

when the firm has 50% or more state ownership or is a small/medium sized firm. When

we interact percentage of sales sold domestically with other firm characteristics such as

age and foreign ownership, we find that none of these firm characteristics have a

significant influence on the extent of innovation of exporters versus non-exporters as

shown by the aggregate indicators

        The underlying indicators reveal some differences however. Exporters who are

older are more likely to sign joint ventures with foreign partners and those that are

foreign owned are more likely to sign joint ventures as well as open new plants.

        While the above results show that competition has a significant impact on

innovation and varies according to the types of firms, we recognize that inclusion of

industry and country dummies may not be sufficient to remove all spurious correlation

between competition and the innovation indicators. In the absence of time series data and

information on policy reforms across our sample of countries that might have allowed us

to correct for the potential endogeneity in the competition measure, we leave the

identification issues in this area for future work.




                                                                                         25

6.     Conclusions

       The strong and independent causal role of finance in promoting growth has been

demonstrated in recent literature using quantitative evidence from around the world. A

large body of empirical work has also demonstrated the importance of good governance

ownership structures and market competition for value creation by firms.

       Understanding how an effective financial system contributes to economic

development and which characteristics of the business environment promote good

governance is crucial to optimize policy recommendations to help develop financial

sectors that promote growth. Since innovation responses to a changing economic

environment are widely considered to be the main driver of the growth process,

understanding the links between finance and firm innovation is an important step in

identifying the channels through which financial development contributes to economic

development.

       Using firm level data for over 19,000 firms in 47 developing countries, this paper

provides evidence that a firm's access to finance is an important determinant of the extent

of innovation it undertakes. We define innovation broadly, to include not only core

innovation activities (introducing new technology, new product lines and upgrading

them), but also other types of activities that promote knowledge transfers (such as signing

joint ventures with foreign partners and obtaining new licensing agreements), as well as

opening or closing plants, discontinuing product lines, and activity sourcing decisions,

which reflect the overall dynamism of firms.

       Our results indicate that the more innovative firms are younger but larger, and are

exporting firms characterized by private ownership, highly educated managers with mid-

level managerial experience, and access to external finance. By contrast, firms that do not

innovate much are typically state owned firms who do not have foreign competitors.

Identity of the controlling shareholder seems to be particularly important for the

introduction of new technology and those private firms whose controlling shareholder is a

financial institution, tend to be the least innovative. We find evidence that the use of

external finance is associated with greater innovation by foreign firms, yet state owned

firms with external financing are even less innovative. Financing from foreign banks is

associated with higher levels of innovation compared to financing from domestic banks



                                                                                         26

and innovation also increases with a greater share of the firm's borrowing in foreign

currency.

        The findings of this paper are consistent with the well-established result in the

literature that financial development and institutions that are associated with good

governance lead to economic growth. In this paper, we provide additional evidence at the

micro level by showing that one of the channels through which access to finance affects

the growth process is through spurring firm innovation. We also find suggestive

evidence that higher competition and good governance are associated with greater

innovation.




                                                                                         27

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                                                                                      31

                                                                         Table 1: Indicators of Firm Innovation
This table presents the proportion of firms in each country undertaking different types of innovations. The variables are described as follows: GDP per capita is real GDP per capita in US dollars in
2000. Developed a major new product line, Upgraded an existing product line, Introduced new technology that has substantially changed the way that the main product is produced, Discontinued at
least one product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing agreement,
Outsourced a major production activity that was previously conducted in-house and Brought in-house a major production activity that was previously outsourced are all dummy variables that take the
value 1 if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by adding 1 if the firm has undertaken any of the ten different innovative
activities except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet. INDEX2 is formed by adding 1 if the firm has Discontinued at least one product
(not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is formed by adding 1 if the firm has Developed a new product line or Introduced a
new technology. Small firms employ 1-19 employees, Medium firms have 20-99 employees, and Large firms have above 100 employees.

                                                        Upgrad                Disco                                                                    Brought
                                                        ed                    ntinue                                New                                in-house a
                                                        existin               d at                   Closed at      JV                     Outsou      previously
                                            New         g           New       least 1                least one      with      New          rced a      out-
                                GDP/        product     product     Techno    produ     Opened a     existing       foreign   Licensing    major       sourced
 Nation                         Capita      line        line        logy      ct        new plant    plant          partner   Agreement    activity    activity      CORE      INDEX8         INDEX2
 Albania                       1007.95        0.43        0.45         0.33    0.11       0.02           0.04        0.05        0.05        0.04         0.12        0.75        1.47           0.15
 Armenia                       629.91         0.31        0.42        0.26     0.19       0.04           0.05        0.09        0.13        0.11         0.10        0.56        1.44           0.24
 Azerbaijan                    533.48         0.31        0.31         0.22    0.14       0.06           0.08        0.09        0.32        0.06         0.04        0.54        1.42           0.22
 Belarus                       1896.41        0.44        0.62        0.33     0.17       0.06           0.07        0.23        0.37        0.21         0.14        0.77        2.41           0.24
 Bhutan                        532.21                                 0.59
 Bosnia and Herzegovina        1594.60        0.39        0.61        0.33     0.11       0.16           0.09        0.16        0.09        0.07         0.06        0.70        1.82           0.20
 Brazil                        4626.34        0.68        0.95        0.68     0.41       0.16           0.08        0.04        0.07        0.28         0.21        1.35        3.06           0.50
 Bulgaria                      1544.94        0.57        0.54        0.31     0.30       0.14           0.10        0.06        0.26        0.04         0.10        0.88        2.01           0.40
 Cambodia                      367.51         0.53        0.90        0.60     0.05       0.18           0.02        0.21        0.21        0.33         0.41        1.14        3.38           0.07
 China                         824.63         0.24        0.40        0.33                                                                                            0.57
 Croatia                       5077.08        0.51        0.74        0.37     0.30       0.27           0.16        0.09        0.13        0.05         0.13        0.86        2.25           0.44
 Czech Republic                5380.49        0.28        0.48        0.23     0.16       0.28           0.13        0.06        0.08        0.05         0.14        0.51        1.61           0.29
 Ecuador                       1705.06        0.52        0.84        0.51     0.44       0.06           0.09        0.11        0.08        0.20         0.10        1.03        2.42           0.53
 Egypt, Arab Rep.              1216.65        0.15        0.23        0.11     0.15                                  0.02        0.01        0.04                     0.25
 El Salvador                   1759.68        0.62        0.82        0.51     0.43       0.06           0.08        0.09        0.04        0.11         0.08        1.13        2.33           0.51
 Estonia                       3792.29        0.29        0.51        0.32     0.22       0.22           0.22        0.05        0.21        0.12         0.06        0.61        1.76           0.44
 Georgia                       768.13         0.33        0.44        0.29     0.28       0.14           0.06        0.06        0.13        0.04         0.08        0.62        1.51           0.34
 Guatemala                     1562.57        0.53        0.82         0.43    0.39       0.08           0.16        0.12        0.04        0.13         0.14        0.96        2.29           0.55
 Honduras                      713.11         0.47        0.72        0.46     0.31       0.07           0.09        0.09        0.04        0.08         0.09        0.92        2.03           0.40
 Hungary                       5439.15        0.24        0.35        0.15     0.22       0.20           0.16        0.04        0.08        0.14         0.09        0.39        1.29           0.37
 Indonesia                     1014.63        0.38        0.68        0.22     0.22       0.07           0.08        0.06        0.08        0.13         0.10        0.58        1.65           0.29
 Kazakhstan                    1547.98        0.34        0.43         0.19    0.19       0.05           0.16        0.06        0.27        0.06         0.03        0.52        1.43           0.34
 Kyrgyz Republic               443.96         0.41        0.54         0.30    0.23       0.11           0.15        0.12        0.20        0.08         0.04        0.71        1.77           0.37
 Latvia                        2608.12        0.37        0.56        0.33     0.26       0.23           0.17        0.05        0.26        0.05         0.03        0.69        1.86           0.43




                                                                                                                                                                                                      32

                                        Upgrad         Disco                                                  Brought
                                        ed             ntinue                      New                        in-house a
                                        existin        d at              Closed at JV                Outsou   previously
                                New     g       New    least 1           least one with    New       rced a   out-
                        GDP/    product product Techno produ   Opened a  existing  foreign Licensing major    sourced
Nation                  Capita  line    line    logy   ct      new plant plant     partner Agreement activity activity   CORE  INDEX8  INDEX2
Lithuania              2617.61    0.49    0.40   0.29   0.31     0.09      0.09     0.07      0.19    0.16       0.06     0.76   1.70    0.38
Macedonia, FYR         2541.06    0.35    0.40   0.32   0.09     0.15      0.04     0.21      0.08    0.22       0.08     0.67   1.80    0.12
Mali                   292.81     0.46    0.59   0.50   0.11     0.11      0.06     0.06      0.05    0.06       0.07     0.94   1.85    0.17
Moldova                424.47     0.51    0.59   0.30   0.34     0.28      0.18     0.07      0.29    0.07       0.14     0.81   2.25    0.52
Nicaragua               502.65    0.47    0.85   0.53   0.37     0.05      0.11     0.09      0.02    0.10       0.08     1.00   2.19    0.48
Oman                   5921.12    0.36    0.46   0.32   0.14     0.21      0.05     0.04      0.07    0.04       0.08     0.20   0.46    0.06
Philippines            1173.14    0.49    0.64   0.42   0.42     0.13      0.11     0.06      0.13    0.21       0.14     0.88   2.14    0.51
Poland                 4337.37    0.43    0.56   0.27   0.18     0.08      0.08     0.01      0.09    0.02       0.02     0.70   1.48    0.25
Romania                1461.46    0.47    0.70   0.31   0.18     0.31      0.15     0.06      0.21    0.07       0.22     0.78   2.35    0.33
Russian Federation     2944.13    0.39    0.50   0.30   0.27     0.12      0.15     0.04      0.38    0.08       0.01     0.68   1.77    0.42
Serbia and Montenegro  1631.59    0.38    0.58   0.36   0.08     0.26      0.12     0.17      0.11    0.07       0.10     0.72   2.01    0.20
Slovak Republic        4303.32    0.33    0.77   0.34   0.27     0.24      0.18     0.05      0.17    0.06       0.09     0.67   2.04    0.45
Slovenia               11646.10   0.28    0.41   0.33   0.20     0.12      0.13     0.17      0.19    0.14       0.13     0.61   1.77    0.32
South Africa           4022.63    0.68    0.84   0.61   0.44     0.20      0.11     0.09      0.10    0.20       0.34     1.28   3.06    0.55
Syrian Arab Republic    792.82    0.42    0.46   0.33   0.21                        0.04      0.06                        0.74
Tajikistan              229.49    0.41    0.55   0.35   0.33     0.03      0.14     0.06      0.18    0.06       0.04     0.76   1.67    0.46
Tanzania                191.75    0.33    0.58   0.32   0.18     0.11      0.07     0.04      0.09    0.05       0.09     0.63   1.57    0.24
Thailand               2827.62    0.50    0.71   0.52   0.19     0.08      0.02     0.04      0.11    0.18       0.11     1.02   2.23    0.21
Turkey                 3047.65    0.18    0.27   0.15   0.07     0.06      0.04     0.04      0.03    0.05       0.04     0.33   0.81    0.10
Uganda                 348.64                    0.47
Ukraine                880.88     0.45    0.57   0.37   0.18     0.10      0.08     0.19      0.19    0.10       0.11     0.83   2.10    0.26
Uzbekistan              654.31    0.28    0.44   0.22   0.16     0.06      0.11     0.05      0.19    0.06       0.05     0.50   1.35    0.27
Zambia                 403.82     0.49    0.69   0.50   0.27     0.34      0.14     0.06      0.06    0.11       0.17     0.99   2.41    0.41
Small (1-19)                      0.33    0.49   0.28   0.19     0.08      0.07     0.05      0.10    0.08       0.09     0.59   1.61    0.27
Medium (20-99)                    0.44    0.63   0.40   0.27     0.12      0.09     0.06      0.11    0.15       0.14     0.82   2.17    0.36
Large (100 and over)              0.51    0.70   0.50   0.32     0.18      0.12     0.12      0.16    0.18       0.15     0.99   2.60    0.44




                                                                                                                                             33

                                                                                  Table 2: Summary Statistics
Panel A presents the summary statistics, Panel B presents the correlation matrix between the firm innovation variables and Panel C between the aggregate innovation variables and firm level variables.
The variables are described as follows: Developed a major new product line, Upgraded an existing product line, Introduced new technology that has substantially changed the way that the main product
is produced, Discontinued at least one product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new
licensing agreement, Outsourced a major production activity that was previously conducted in-house and Brought in-house a major production activity that was previously outsourced are all dummy
variables that take the value 1 if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by adding 1 if the firm has undertaken any of the ten
different innovative activities except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet. INDEX2 is formed by adding 1 if the firm has Discontinued
at least one product (not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is formed by adding 1 if the firm has Developed a new product
line or Introduced a new technology. Log GDP/capita is the logarithm of GDP per capita in 2000. Small firms employ 1-19 employees, Medium firms have 20-99 employees, and Large firms have
above 100 employees. Firm age is the year of the survey (2000)-year established. Number of establishments is the number of separate operating facilities a firm has. Corporations is a dummy variable
that takes the value 1 if the firm is legally incorporated and 0 if the firm is organized as a cooperative, sole proprietorship, partnership or has another legal form. Capacity Utilization takes values 1 to 3
corresponding to capacity utilization levels below 50%, between 50% and 80% and above 80%.

Panel A: Summary Statistics

                                                                                                Standard
  Variable                                                              N           Mean        Deviation      Minimum      Maximum
  Individual Innovation Indicators
  New product line                                                   19031          0.42           0.5             0             1
  Upgraded existing product line                                     19028           0.6          0.49             0             1
  New Technology                                                     19417          0.39          0.49             0             1
  Discontinued at least 1 product                                    16644          0.26          0.44             0              1
  Opened a new plant                                                 15121          0.13          0.33             0             1
  Closed at least one existing plant                                 15111          0.09          0.29             0              1
  New JV with foreign partner                                        16638          0.07          0.26             0             1
  New Licensing Agreement                                            16647          0.12          0.32             0             1
  Outsourced a major activity                                        16093          0.13          0.34             0             1
  Brought in-house a previously out-sourced activity                 15127          0.13          0.33             0             1
  Aggregate Innovation Indicators
  CORE                                                               19415          0.79          0.81             0             2
  INDEX8                                                             15478          2.08          1.68             0             8
  INDEX2                                                             15478          0.35          0.57             0             2

  Control Variables
  Log (GDP/Capita)                                                     47            7.3          0.87           5.26           9.36
  Firm Size                                                          19684          1.91           0.8             1             3
  Age                                                                19760          16.55         16.31            0            202
  Number of Establishments                                           15314          2.05          5.89             0            200
  Corporations                                                       18963          0.43          0.49             0             1
  Capacity Utilization                                               17982           2.4          0.67             1             3




                                                                                                                                                                                                            34

Panel B: Correlation Matrix between the Firm Innovation Indicators

                                                                                                               Closed at
                                                           Upgraded                Discontinued                least one   New JV        New         Outsourced
                                             New           existing     New        at least 1     Opened a     existing    with foreign  Licensing   a major
                                             product line  product line Technology product        new plant    plant       partner       Agreement   activity

  Upgraded existing product line               0.4612a

  New Technology                               0.3787a        0.4424a

  Discontinued at least 1 product              0.2777a        0.2297a    0.2004a

  Opened a new plant                           0.1678a        0.1186a    0.1485a      0.0960a


  Closed at least one existing plant           0.0491a        0.0366a    0.0315b      0.2003a      0.2148a

  New JV with foreign partner                  0.1366a        0.1112a    0.1177a      0.0623a      0.1340a       0.0976a

  New Licensing Agreement                      0.1281a        0.0827a    0.1066a      0.0749a      0.1595a       0.1080a      0.2229a

  Outsourced a major activity                  0.1672a        0.1735a    0.1882a      0.1305a      0.1151a       0.0881a      0.1509a      0.1267a
  Brought in-house a previously out-
  sourced activity                             0.1746a        0.1699a    0.1832a      0.1117a      0.1292a       0.0764a      0.1114a      0.0966a     0.2946a
a b
 , , and represent significance at 1%, 5% and 10% respectively
        c



Panel C: Correlation Matrix between the Aggregate Innovation/Innovation Indicators and the Firm Level Variables

                                                                                                                          Number of
                                             INDEX8        CORE         INDEX2     LGCAP        Size           Age        Establishments Corporations

  CORE                                         0.8116a

  INDEX2                                       0.3168a        0.2612a

  LGCAP                                        0.0145c        0.0717a    0.0326a

  Size                                         0.2405a        0.1967a    0.1236a     0.0711a

  Age                                          0.0513a        0.0340a    0.1177a     0.0604a      0.2767a

  Number of Establishments                     0.0477a        0.0185b    0.0562a     0.0280a      0.1354a       0.0764a

  Corporations                                 0.2089a        0.2025a    0.0776a     0.1982a      0.2555a       0.0148b      0.0102

  Capacity Utilization                         0.0172b        0.0605a    -0.0726a    0.1689a      0.0937a       -0.0563a     0.0378a         0.0295a
a b
 , , and represent significance at 1%, 5% and 10% respectively
        c




                                                                                                                                                                  35

                                                                     Table 3: Determinants of Firm Innovation
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies + 7
Industry Dummies + 8 Country Dummies + . The variables are described as follows: GDP per capita is real GDP per capita in US dollars in 2000. Innovation is one of the following variables:
Developed a major new product line, Upgraded an existing product line, Introduced new technology that has substantially changed the way that the main product is produced, Discontinued at least one
product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing agreement, Outsourced a
major production activity that was previously conducted in-house and Brought in-house a major production activity that was previously outsource, INDEX8, INDEX2 and Core. Each of the first ten
innovation indicators is a dummy variable that take the value 1 if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by adding 1 if the
firm has undertaken any of the ten different innovative activities except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet. INDEX2 is formed by
adding 1 if the firm has Discontinued at least one product (not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is formed by adding 1 if
the firm has Developed a new product line or Introduced a new technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Firm Size Dummies consist of three dummies corresponding
to small, medium, and large firms. Small firms employ 1-19 employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the survey (2000) - year
established. Number of establishments is the number of separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally incorporated and 0 if the firm
is organized as a cooperative, sole proprietorship, partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity utilization levels below 50%,
between 50% and 80% and above 80%. Logit regressions are used for the individual indicators (columns 1-10) and Ordered Logit regressions are used for the aggregate indices (columns 11-13). The p-
value for the joint significance test of the industry dummies and the p-values for Chi-square test of Medium Firms being the same as Large firms are also reported. Detailed variable definitions and
sources are in the appendix.
                                1            2           3             4              5          6            7            8             9             10             11            12           13

                                                                                                                                                   Brought
                                                                                             Closed                                                in-house a
                                        Upgraded                                             at least     New JV                                   previously
                            New         existing      New        Discontinued     Opened     one          with        New           Outsourced     out-
                            product     product       Techno     at least 1       a new      existing     foreign     Licensing     a major        sourced
                            line        line          logy       product          plant      plant        partner     Agreement     activity       activity        CORE         INDEX8        INDEX2
  Log (GDP/Capita)           -0.244b      -0.015       0.014         0.306b        0.909a     0.600a       0.591a       0.602a        0.522a         0.093         -0.165c        -0.055       0.319a
                             [0.098]      [0.093]     [0.097]       [0.128]       [0.257]     [0.194]      [0.173]      [0.168]       [0.182]       [0.135]        [0.088]       [0.081]       [0.120]
  Medium                     0.422a       0.427a       0.331a        0.247a        0.622a     0.360a       0.627a       0.336a        0.358a         0.424a        0.426a         0.528a       0.305a
                             [0.048]      [0.052]     [0.049]       [0.054]       [0.077]     [0.083]      [0.099]      [0.073]       [0.074]       [0.077]        [0.043]       [0.041]       [0.052]
  Large                      0.718a       0.745a       0.740a        0.490a        1.155a     0.774a       1.353a       0.773a        0.537a         0.572a        0.820a         0.995a       0.597a
                             [0.056]      [0.062]     [0.057]       [0.063]       [0.082]     [0.091]      [0.104]      [0.080]       [0.083]       [0.086]        [0.051]       [0.048]       [0.059]
  Age                        -0.004a      -0.003b     -0.004a        0.004a        -0.011a    0.006a       -0.004c      -0.002        -0.001        -0.006a        -0.005a        -0.006a      0.006a
                             [0.001]      [0.001]     [0.001]       [0.001]       [0.002]     [0.002]      [0.002]      [0.002]       [0.002]       [0.002]        [0.001]       [0.001]       [0.001]
  Corporation                0.156a       0.252a       0.222a        0.204a         0.102      -0.13       0.284a       0.330a        0.223a         0.198b        0.207a         0.323a       0.138b
                             [0.052]      [0.055]     [0.054]       [0.060]       [0.074]     [0.084]      [0.094]      [0.075]       [0.077]       [0.078]        [0.047]       [0.044]       [0.056]

  Number of
  establishments                0         0.003        0.003         0.004         0.022a     0.018a       0.009b        0.003        0.008b         -0.007         0.002         0.010a       0.013a
                             [0.003]      [0.004]     [0.003]       [0.004]       [0.004]     [0.003]      [0.004]      [0.004]       [0.004]       [0.006]        [0.003]       [0.003]       [0.003]
  Capacity Utilization
  between [50%, 80%]         0.238a       0.286a       0.342a        -0.034        -0.079     -0.236b        0.03        0.139        -0.064         0.032         0.314a         0.198a       -0.131c
                             [0.073]      [0.078]     [0.075]       [0.078]       [0.116]     [0.114]      [0.134]      [0.118]       [0.106]       [0.113]        [0.066]       [0.063]       [0.076]




                                                                                                                                                                                                          36

                               1           2         3             4         5         6        7        8          9         10       11       12        13

                                                                                                                          Brought
                                                                                   Closed                                 in-house a
                                       Upgraded                                    at least  New JV                       previously
                           New         existing  New         Discontinued Opened   one       with    New       Outsourced out-
                           product     product   Techno      at least 1   a new    existing  foreign Licensing a major    sourced
                           line        line      logy        product      plant    plant     partner Agreement activity   activity   CORE    INDEX8    INDEX2
  Capacity
  Utilization>=80%          0.331a       0.295a   0.447a        -0.274a    -0.025  -0.565a   -0.221c   0.087      -0.03     0.032    0.417a   0.229a    -0.383a
                            [0.072]     [0.077]   [0.075]       [0.079]   [0.115]  [0.115]   [0.134]  [0.117]    [0.106]   [0.113]   [0.066]  [0.063]   [0.076]
  Constant                   1.265       -0.141   -1.104        -3.858a   -10.951a -7.376a   -7.301a  -8.278a    -6.963a   -2.839b
                            [0.808]     [0.781]   [0.814]       [1.098]   [2.341]  [1.731]   [1.548]  [1.511]    [1.618]   [1.146]
  Observations              13823        13818     13889         13817     13476    13454     13763    13791     13472      13483    13886    13541     13541
  Pseudo R-square           0.0942       0.1722   0.1174         0.0912   0.1024   0.0775     0.1252   0.111     0.1012    0.1118    0.0964   0.0734    0.0713

  F-Test
  Medium= Large                0           0         0             0         0         0        0        0       0.0065       0         0        0         0

  Joint Significance
  Test of Industry
  Dummies                      0           0         0             0         0         0        0        0          0       0.033       0        0         0
a b
 , , and represent significance at 1%, 5% and 10% respectively
        c




                                                                                                                                                               37

                                                                Table 4: Effect of Financing on Firm Innovation
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies +7
External Financing (or Bank Loan dummy) +8 Equity +9 Local Banks +10 Foreign Banks +11 Leasing +12 Investment Funds +13 Trade Credit +14 Credit Cards +15 Family +16 Informal Sector
(eg: moneylender) +17 Other + 18 Foreign Currency Borrowing+19 Necessity of Collateral + 20 Industry Dummies + 21 Country Dummies + . The variables are described as follows: GDP per
capita is real GDP per capita in US dollars in 2000. Innovation is one of the following variables: Developed a major new product line, Upgraded an existing product line, Introduced new technology that
has substantially changed the way that the main product is produced, Discontinued at least one product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to
a new joint venture with foreign partner, Obtained a new licensing agreement, Outsourced a major production activity that was previously conducted in-house and Brought in-house a major production
activity that was previously outsource, INDEX8, INDEX2 and Core. Each of the first ten innovation indicators is a dummy variable that take the value 1 if the firm undertook the corresponding
innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by adding 1 if the firm has undertaken any of the ten different innovative activities except Discontinued at least one product
(not production) line and Closed at least one existing plant or outlet. INDEX2 is formed by adding 1 if the firm has Discontinued at least one product (not production) line or Closed at least one existing
plant or outlet. CORE is an aggregate measure of innovation that is formed by adding 1 if the firm has Developed a new product line or Introduced a new technology. Log (GDP/capita) is the logarithm
of GDP per capita in 2000. Firm Size Dummies consist of three dummies corresponding to small, medium, and large firms. Small firms employ 1-19 employees, Medium firms have 20-99 employees,
and Large firms have above 100 employees. Age is the year of the survey (2000) - year established. Number of establishments is the number of separate operating facilities a firm has. Corporations is a
dummy variable that takes the value 1 if the firm is legally incorporated and 0 if the firm is organized as a cooperative, sole proprietorship, partnership or has another legal form. Capacity Utilization
Dummies consist of three dummies corresponding to capacity utilization levels below 50%, between 50% and 80% and above 80%. External Financing is the proportion of new investments financed
externally and is given by 100-Proportion of new investments financed through internal funds or retained earnings. Bank Loan Dummy takes the value 1 if the firm had a bank loan approved prior to
2001 and 0 if it did not have a bank loan. Local Banks, Foreign Banks, Leasing, Investment Funds, Trade Credit, Credit Cards, Equity, Family, Informal Sources and Other represent proportion of new
investments financed by local commercial banks, foreign owned commercial banks, leasing arrangements, investment funds or special development financing, supplier or customer credit, credit cards,
sale of stock, family and friends, informal sources such as moneylenders and other. Foreign Currency Borrowing is the total borrowing denominated in foreign currency and Necessity of Collateral is a
dummy variable that takes the value 1 of the financing required collateral or a deposit and 0 otherwise. Logit regressions are used for the individual indicators (columns 1-10) and Ordered Logit
regressions are used for the aggregate indices (columns 11-13). The regressions with external financing sources also present the p-values for the corresponding Chi-square test (F-tests for columns 10-
13) for testing Local Bank financing is the same as Foreign Bank financing. Detailed variable definitions and sources are in the appendix.



                               1            2           3               4             5           6           7            8             9             10           11            12            13
                                                                                                                                                   Brought
                                                                                             Closed                                                in-house a
                                        Upgraded                                             at least    New JV                                    previously
                           New          existing     New         Discontinued     Opened     one         with        New            Outsourced     out-
                           product      product      Techno      at least 1       a new      existing    foreign     Licensing      a major        sourced
                           line         line         logy        product          plant      plant       partner     Agreement      activity       activity      CORE        INDEX8         INDEX2
 External Financing          0.002a       0.002a        0            0.001c        0.003a       0.001     0.004a        0.002b        0.002b          0.001       0.001b        0.002a        0.001c
                            [0.001]      [0.001]     [0.001]        [0.001]        [0.001]     [0.001]    [0.001]      [0.001]        [0.001]        [0.001]      [0.001]      [0.000]        [0.001]
 External Financing Sources of New Investments
 Equity                        0          0.004       0.001         -0.007a        0.004       -0.006     0.007c        0.003         0.009b          0.01         0.001        0.006         -0.007a
                            [0.003]      [0.007]     [0.004]        [0.002]        [0.003]     [0.004]    [0.004]      [0.002]        [0.004]        [0.007]      [0.004]      [0.006]        [0.003]
 Local Bank                  0.001        0.003       0.002          -0.003           0        -0.003     -0.001           0           0.002            0          0.002        0.002         -0.003
                            [0.002]      [0.003]     [0.002]        [0.003]        [0.002]     [0.004]    [0.003]      [0.001]        [0.001]        [0.002]      [0.002]      [0.002]        [0.003]
 Foreign Bank                0.004c       0.007c      0.007a         0.003         0.015a       0.002     0.012a        0.007b         0.001          0.003       0.006a        0.010a         0.003
                            [0.002]      [0.004]     [0.003]        [0.002]        [0.002]     [0.003]    [0.003]      [0.003]        [0.003]        [0.004]      [0.002]      [0.003]        [0.002]
 Leasing                     0.007a       0.007a      0.005a         0.004b        0.008a       0.002     0.004c        0.002          0.001          0.002       0.006a        0.007a        0.004b
                            [0.002]      [0.002]     [0.002]        [0.002]        [0.002]     [0.002]    [0.003]      [0.003]        [0.002]        [0.004]      [0.002]      [0.002]        [0.001]




                                                                                                                                                                                                        38

                               1           2         3             4         5        6        7        8          9         10       11       12        13
                                                                                                                         Brought
                                                                                  Closed                                 in-house a
                                       Upgraded                                   at least  New JV                       previously
                           New         existing  New         Discontinued Opened  one       with    New       Outsourced out-
                           product     product   Techno      at least 1   a new   existing  foreign Licensing a major    sourced
                           line        line      logy        product      plant   plant     partner Agreement activity   activity   CORE    INDEX8    INDEX2
  Investment Fund           0.008a       0.020a   0.008a           0       0.010a   0.003    0.001    0.005b     0.005     0.010a   0.009a   0.010a     0.001
                            [0.002]     [0.006]   [0.003]       [0.001]   [0.001]  [0.003]  [0.003]  [0.002]    [0.003]   [0.004]   [0.002]  [0.002]   [0.002]
  Trade Credit              0.007a       0.011a   0.005a         0.003b    0.004b   0.002    0.003    -0.001    0.004a     0.005b   0.007a   0.007a    0.003c
                            [0.002]     [0.002]   [0.002]       [0.001]   [0.002]  [0.002]  [0.002]  [0.002]    [0.002]   [0.002]   [0.002]  [0.001]   [0.001]
  Credit Card               0.013b       0.006    -0.002         0.001     0.009c   0.002    0.010b   -0.007     0.006     -0.005    0.006    0.005     0.001
                            [0.005]     [0.006]   [0.004]       [0.005]   [0.005]  [0.005]  [0.005]  [0.007]    [0.006]   [0.007]   [0.004]  [0.004]   [0.004]
  Family                    0.005c       0.007b    0.003         -0.002    0.009a  0.003c    0.003    0.001      0.007     0.007a   0.005c   0.007b       0
                            [0.003]     [0.003]   [0.002]       [0.001]   [0.003]  [0.002]  [0.003]  [0.002]    [0.005]   [0.002]   [0.003]  [0.003]   [0.002]
  Informal                   0.003       0.005     0.002         0.001     -0.001  -0.001    -0.005   0.001     -0.001     0.006     0.001    0.001     0.001
                            [0.003]     [0.003]   [0.003]       [0.003]   [0.004]  [0.004]  [0.006]  [0.003]    [0.003]   [0.004]   [0.003]  [0.003]   [0.003]
  Other                      0.001       0.002     0.001         0.001     0.002   0.003c    0.003    0.001     0.004c     0.001     0.001    0.002     0.001
                            [0.001]     [0.002]   [0.001]       [0.002]   [0.002]  [0.002]  [0.002]  [0.002]    [0.003]   [0.004]   [0.001]  [0.002]   [0.002]
  Bank Loan Dummy            0.055       0.196b    0.112         0.169b    -0.031   0.17     0.118    0.311a    0.146c     0.137    0.103c   0.162a    0.175b
                            [0.069]     [0.088]   [0.069]       [0.072]   [0.104]  [0.119]  [0.133]  [0.112]    [0.085]   [0.091]   [0.062]  [0.058]   [0.068]
  Necessity of
  collateral                -0.072       -0.045    0.092        -0.170b   -0.248b  -0.241b   -0.151   0.076     0.180b     0.163c   -0.016    -0.01    -0.201a
                            [0.066]     [0.076]   [0.067]       [0.073]   [0.097]  [0.112]  [0.124]  [0.096]    [0.086]   [0.093]   [0.060]  [0.055]   [0.069]
  Share of borrowing
  in foreign currency       0.005a       0.003a    0.001         0.003a    0.006a  0.005a    0.010a   0.005a    0.003a     0.003b   0.004a   0.005a    0.004a
                            [0.001]     [0.001]   [0.001]       [0.001]   [0.001]  [0.001]  [0.001]  [0.001]    [0.001]   [0.001]   [0.001]  [0.001]   [0.001]
  Tests of Significance
  F-Test
  Local Bank=Foreign
  Bank                      0.2367       0.4696   0.0861         0.0719      0     0.1707    0.0008  0.0114     0.7557    0.3641     0.122   0.0089    0.0716

a b
 , , and represent significance at 1%, 5% and 10% respectively
        c




                                                                                                                                                              39

                                                               Table 5: Effect of Ownership on Firm Innovation
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies +7
State Ownership +8 Domestic Company + 9 Individual+10 Family+ 11 Financial Institution +12 Managers +13Employees+14Corporation+ 15 Industry Dummies + 16 Country Dummies + . The
variables are described as follows: GDP per capita is real GDP per capita in US dollars in 2000. Innovation is one of the following variables: Developed a major new product line, Upgraded an existing
product line, Introduced new technology that has substantially changed the way that the main product is produced, Discontinued at least one product (not production) line, Opened a new plant, Closed
at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing agreement, Outsourced a major production activity that was previously conducted in-
house and Brought in-house a major production activity that was previously outsource, INDEX8, INDEX2 and Core. Each of the first ten innovation indicators is a dummy variable that take the value 1
if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by adding 1 if the firm has undertaken any of the ten different innovative activities
except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet. INDEX2 is formed by adding 1 if the firm has Discontinued at least one product (not
production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is formed by adding 1 if the firm has Developed a new product line or Introduced a new
technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Firm Size Dummies consist of three dummies corresponding to small, medium, and large firms. Small firms employ 1-19
employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the survey (2000) - year established. Number of establishments is the number of
separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally incorporated and 0 if the firm is organized as a cooperative, sole proprietorship,
partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity utilization levels below 50%, between 50% and 80% and above 80%. State
Ownership is a dummy variable that takes the value 1if the state owns 50% or more of the company and 0 otherwise. Domestic Company is a dummy variable that takes the value 1 if the domestic
private sector owns more than 50%. Individual, Family, Financial Institution, Managers, Employees and Domestic Corporation are dummy variables which take the value 1 if the largest shareholder or
owner in the firm is an individual, family, bank or investment fund, manager of the firm, employees of the firm, domestic corporation or government/government agency. Logit regressions are used for
the individual indicators (columns 1-10) and Ordered Logit regressions are used for the aggregate indices (columns 11-13). Detailed variable definitions and sources are in the appendix.

                                1            2          3               4            5           6           7             8             9             10           11            12           13


                                                                                                                                                   Brought
                                                                                             Closed                                                in-house a
                                        Upgraded                                             at least    New JV                                    previously
                            New         existing     New          Discontinued    Opened     one         with         New           Outsourced     out-
                            product     product      Techno       at least 1      a new      existing    foreign      Licensing     a major        sourced
                            line        line         logy         product         plant      plant       partner      Agreement     activity       activity      CORE        INDEX8        INDEX2
  State Ownership            -0.364a      -0.475a    -0.378a          -0.126      -0.683a      0.138      -0.532a       -0.453a        -0.13         -0.051      -0.420a       -0.545a       -0.027
                             [0.090]     [0.090]     [0.094]         [0.104]      [0.141]     [0.128]     [0.159]       [0.117]       [0.147]        [0.151]     [0.082]       [0.075]       [0.095]
  Domestic                   -0.082       -0.123c     0.013           -0.003       -0.043     0.260b      -0.749a       -0.186b       -0.164c        0.155c       -0.032       -0.140a        0.082
                             [0.063]     [0.069]     [0.064]         [0.070]      [0.083]     [0.108]     [0.093]       [0.081]       [0.086]        [0.091]     [0.056]       [0.053]       [0.066]
  Identity of the Controlling Shareholder
  Individual                  0.084       0.142       0.276a          0.225b       0.116       0.137        0.09        -0.022        -0.039         0.247c       0.221a        0.132c       0.190c
                             [0.090]     [0.095]     [0.091]         [0.110]      [0.151]     [0.187]     [0.197]       [0.136]       [0.126]        [0.149]     [0.083]       [0.078]       [0.104]
  Family                     0.269b       0.084       0.468a          0.153        0.402b      0.146      0.369c         0.062        -0.156          0.021       0.419a        0.211b        0.142
                             [0.108]     [0.119]     [0.109]         [0.127]      [0.172]     [0.209]     [0.223]       [0.169]       [0.153]        [0.173]     [0.098]       [0.092]       [0.120]
  Financial Institution      -0.429       -0.203     -1.392a          -0.042       -0.184      0.502      -0.373        -1.661b        0.454         0.885c      -0.812b       -0.409         0.163
                             [0.403]     [0.397]     [0.512]         [0.470]      [0.508]     [0.510]     [0.626]       [0.758]       [0.542]        [0.495]     [0.368]       [0.331]       [0.430]
  Managers                    0.273       0.396b      0.564a          0.216        0.088       0.117      0.532c        0.385c         0.196          0.292       0.503a        0.483a        0.215
                             [0.181]     [0.193]     [0.184]         [0.213]      [0.277]     [0.319]     [0.321]       [0.231]       [0.264]        [0.269]     [0.162]       [0.155]       [0.198]
  Employees                  -0.156       -0.005      0.204           0.597a       -0.369      0.024       -0.17        -0.072        -0.123          0.237       0.066        -0.007        0.425b
                             [0.191]     [0.189]     [0.193]         [0.208]      [0.317]     [0.309]     [0.354]       [0.230]       [0.307]        [0.315]     [0.171]       [0.157]       [0.197]




                                                                                                                                                                                                       40

                               1           2         3             4         5        6        7        8          9         10       11       12        13


                                                                                                                         Brought
                                                                                  Closed                                 in-house a
                                       Upgraded                                   at least  New JV                       previously
                           New         existing  New         Discontinued Opened  one       with    New       Outsourced out-
                           product     product   Techno      at least 1   a new   existing  foreign Licensing a major    sourced
                           line        line      logy        product      plant   plant     partner Agreement activity   activity   CORE    INDEX8    INDEX2
  Domestic
  Corporation                0.069       0.217c    0.164         0.369a    -0.025   0.312    0.504b   -0.026     0.168     0.119     0.143    0.132    0.355a
                            [0.121]     [0.130]   [0.122]       [0.139]   [0.184]  [0.217]  [0.234]  [0.171]    [0.167]   [0.187]   [0.109]  [0.102]   [0.131]
  F-Test
  All Coefficients are
  equal to each other       0.0205       0.3851   0.0001         0.1535   0.0119   0.7753    0.0143  0.0763     0.2344    0.1541    0.0001   0.0279    0.3287
a b
 , , and represent significance at 1%, 5% and 10% respectively
        c




                                                                                                                                                              41

                                                              Table 6: Effect of Competition on Firm Innovation
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Corporations +5 Number of Establishments + 6 Capacity Utilization Dummies +7
Competition + 8 Industry Dummies + 9 Country Dummies + . The variables are described as follows: GDP per capita is real GDP per capita in US dollars in 2000. Innovation is one of the following
variables: Developed a major new product line, Upgraded an existing product line, Introduced new technology that has substantially changed the way that the main product is produced, Discontinued at
least one product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing agreement,
Outsourced a major production activity that was previously conducted in-house and Brought in-house a major production activity that was previously outsource, INDEX8, INDEX2 and Core. Each of
the first ten innovation indicators is a dummy variable that take the value 1 if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by
adding 1 if the firm has undertaken any of the ten different innovative activities except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet. INDEX2 is
formed by adding 1 if the firm has Discontinued at least one product (not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is formed by
adding 1 if the firm has Developed a new product line or Introduced a new technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Firm Size Dummies consist of three dummies
corresponding to small, medium, and large firms. Small firms employ 1-19 employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the survey
(2000) - year established. Number of establishments is the number of separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally incorporated
and 0 if the firm is organized as a cooperative, sole proprietorship, partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity utilization
levels below 50%, between 50% and 80% and above 80%. Competition is one of the following variables: Number of competitors is the total number of competitors in the domestic market that are
private domestic enterprises, state-owned enterprises or foreign-owned enterprises, Percentage of sales sold domestically is the percentage of establishment sales that are sold domestically (instead of
being exported), Firm's Technology compared to that of its competitor takes values 1, 2 or 3 depending on whether the technology is less advanced, about the same or more advanced than that of its
main competitor, Foreign Competition had greatest influence to reduce production costs and Foreign Competition had greatest influence to develop new products are dummy variables that take value 1
if foreign competition had the greatest influence on the firm to reduce production costs or develop new products respectively and 0 otherwise, Does the firm have a foreign competitor and Does the firm
have a state competitor are dummy variables that take the value 1 if over the last year, in the company's main product line, the firm had at least one foreign owned firm as a competitor or a state owned
firm as a competitor respectively. Each cell in the table corresponds to a particular regression. Logit regressions are used for the individual indicators (columns 1-10) and Ordered Logit regressions are
used for the aggregate indices (columns 11-13). Detailed variable definitions and sources are in the appendix.


                               1            2            3             4               5          6            7            8              9             10           11            12              13


                                                                                                                                                     Brought
                                                                                              Closed                                                 in-house a
                                        Upgraded                                              at least     New JV                                    previously
                           New          existing     New         Discontinued      Opened     one          with        New            Outsourced     out-
                           product      product      Techno      at least 1        a new      existing     foreign     Licensing      a major        sourced
                           line         line         logy        product           plant      plant        partner     Agreement      activity       activity      CORE         INDEX8        INDEX2
  Number of
  competitors                0.001        0.002       0.002          -0.003         -0.018a       0         -0.007       -0.010b         -0.005        0.017a       0.001         0.001          -0.001
                            [0.003]      [0.003]     [0.003]        [0.003]         [0.004]    [0.005]      [0.005]      [0.004]        [0.003]        [0.003]     [0.002]       [0.002]        [0.003]
  Percentage of sales
  sold domestically          -0.001      -0.002b     -0.001c         0.001          -0.002b       0         -0.015a      -0.003a         -0.001        -0.001      -0.001b       -0.003a          0.001
                            [0.001]      [0.001]     [0.001]        [0.001]         [0.001]    [0.001]      [0.001]      [0.001]        [0.001]        [0.001]     [0.001]       [0.001]        [0.001]
  Firm's technology
  compared to
  competitor                 0.315a       0.371a      0.492a         -0.04          0.293a     -0.120b      0.327a       0.249a          0.109b        0.146a       0.445a        0.415a         -0.053
                            [0.032]      [0.035]     [0.033]        [0.035]         [0.047]    [0.050]      [0.059]      [0.047]        [0.046]        [0.047]     [0.029]       [0.027]        [0.032]
  Does the firm have a
  foreign competitor?        0.235a       0.298a      0.257a         0.149b         -0.002      0.236c      0.384a        0.003          0.368a        0.504a       0.278a        0.377a         0.193a
                            [0.070]      [0.083]     [0.071]        [0.076]         [0.113]    [0.128]      [0.145]      [0.124]        [0.093]        [0.098]     [0.063]       [0.060]        [0.073]




                                                                                                                                                                                                        42

                               1           2         3             4         5        6        7        8          9         10       11       12        13


                                                                                                                         Brought
                                                                                  Closed                                 in-house a
                                       Upgraded                                   at least  New JV                       previously
                           New         existing  New         Discontinued Opened  one       with    New       Outsourced out-
                           product     product   Techno      at least 1   a new   existing  foreign Licensing a major    sourced
                           line        line      logy        product      plant   plant     partner Agreement activity   activity   CORE    INDEX8    INDEX2
  Does the firm have a
  state competitor?         -0.048       -0.035    -0.03        -0.407b    0.157    0.233    -0.248   -0.145    -0.255     0.127    -0.017   -0.043       .
                            [0.149]     [0.168]   [0.152]       [0.166]   [0.225]  [0.234]  [0.308]  [0.271]    [0.210]   [0.197]   [0.133]  [0.123]
  Foreign Competition
  had greatest influence
  to reduce production
  costs                     0.183b       0.102     0.097         0.135     0.302b   0.147    0.707a   0.445a     0.063     -0.024   0.168b   0.268a    0.142c
                            [0.088]     [0.122]   [0.088]       [0.088]   [0.123]  [0.139]  [0.139]  [0.142]    [0.108]   [0.115]   [0.079]  [0.075]   [0.084]
  Foreign Competition
  had greatest influence
  to develop new
  products                   0.142       0.084    0.166c         0.166c    0.089    0.002    0.634a   0.113     0.212c     0.291b   0.167b   0.272a     0.128
                            [0.092]     [0.128]   [0.093]       [0.092]   [0.137]  [0.152]  [0.146]  [0.159]    [0.112]   [0.116]   [0.083]  [0.078]   [0.089]
a b
 , , and represent significance at 1%, 5% and 10% respectively
         c




                                                                                                                                                              43

                                                            Table 7: Effect of Human Capital on Firm Innovation
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies +7
Human Capital Indicator + 8 Industry Dummies + 9 Country Dummies + . The variables are described as follows: GDP per capita is real GDP per capita in US dollars in 2000. Innovation is one of
the following variables: Developed a major new product line, Upgraded an existing product line, Introduced new technology that has substantially changed the way that the main product is produced,
Discontinued at least one product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing
agreement, Outsourced a major production activity that was previously conducted in-house and Brought in-house a major production activity that was previously outsource, INDEX8, INDEX2 and Core.
Each of the first ten innovation indicators is a dummy variable that take the value 1 if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed
by adding 1 if the firm has undertaken any of the ten different innovative activities except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet.
INDEX2 is formed by adding 1 if the firm has Discontinued at least one product (not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is
formed by adding 1 if the firm has Developed a new product line or Introduced a new technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Firm Size Dummies consist of three
dummies corresponding to small, medium, and large firms. Small firms employ 1-19 employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the
survey (2000) - year established. Number of establishments is the number of separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally
incorporated and 0 if the firm is organized as a cooperative, sole proprietorship, partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity
utilization levels below 50%, between 50% and 80% and above 80%. Human Capital Indicator is one of the following variables: Top Manager's Total Years of Experience is the total number of years of
experience the top manager has had in working in this sector before running the establishment; Mid-Level Experience is a dummy variable that takes the value 1 if the top manager has had between 3-10
years of experience working in this sector before running the establishment; Highly experienced is a dummy variable that takes the value 1 if the top manager has had more than 10 years of experience
working in this sector before running the establishment; Skilled Foreign workers is the percentage of permanent skilled workers that are foreign nationals; Highest education level of the manager takes
values 1 to 6 according to the following categories-did not complete secondary school, secondary school, vocational training, some university training, graduate degree and post graduate degree;
Percentage of workforce with more than 12 years of education is the percentage of workforce at the establishment that has attended university or higher and had more than 12 years of education. Each
cell in the table corresponds to a particular regression. Logit regressions are used for the individual indicators (columns 1-10) and Ordered Logit regressions are used for the aggregate indices (columns
11-13). Detailed variable definitions and sources are in the appendix.
                                1             2           3              4             5             6           7            8             9            10            11           12             13


                                                                                                                                                     Brought
                                                                                                 Closed                                              in-house a
                                         Upgraded                                                at least    New JV                                  previously
                            New          existing      New        Discontinued     Opened        one         with        New          Outsourced     out-
                            product      product       Techno     at least 1       a new         existing    foreign     Licensing    a major        sourced
                            line         line          logy       product          plant         plant       partner     Agreement    activity       activity       CORE        INDEX8         INDEX2
 Top Mgr's total years
 of experience                0.002        0.002        0.004            0             0          -0.005       0.004        0.003           0           0.006        0.003         0.001            0
                             [0.003]      [0.003]      [0.003]       [0.003]        [0.004]      [0.005]      [0.006]      [0.005]       [0.004]       [0.004]      [0.003]       [0.002]       [0.003]
 Mid-level experience        0.123c        0.293a       0.160b        -0.009         0.119         0.112       0.207       0.249c         0.115         0.11         0.158b       0.191a         0.006
                             [0.071]      [0.089]      [0.072]       [0.075]        [0.113]      [0.128]      [0.158]      [0.129]       [0.092]       [0.103]      [0.065]       [0.061]       [0.074]
 Highly experienced           0.098        0.121c       0.103c        -0.006         0.042        -0.125       0.227c       0.131         0.019        0.242a        0.098c       0.103b         -0.032
                             [0.060]      [0.074]      [0.060]       [0.062]        [0.094]      [0.111]      [0.129]      [0.111]       [0.078]       [0.083]      [0.054]       [0.052]       [0.061]
 Skilled foreign
 workers                      0.003        -0.001       0.004         0.002          0.002        -0.005       0.009c      -0.004         0.006        -0.008        0.003         0.003         -0.002
                             [0.003]      [0.004]      [0.003]       [0.004]        [0.004]      [0.006]      [0.005]      [0.005]       [0.004]       [0.005]      [0.003]       [0.003]       [0.004]
 % workforce with
 >12 yrs years
 education                   0.005a        0.003a       0.003a        0.003a           0          -0.001       0.015a      0.006a        0.005a         0.002        0.004a       0.006a         0.002b
                             [0.001]      [0.001]      [0.001]       [0.001]        [0.001]      [0.001]      [0.001]      [0.001]       [0.001]       [0.001]      [0.001]       [0.001]       [0.001]




                                                                                                                                                                                                         44

                               1           2         3             4         5        6        7        8          9         10       11       12        13


                                                                                                                         Brought
                                                                                  Closed                                 in-house a
                                       Upgraded                                   at least  New JV                       previously
                           New         existing  New         Discontinued Opened  one       with    New       Outsourced out-
                           product     product   Techno      at least 1   a new   existing  foreign Licensing a major    sourced
                           line        line      logy        product      plant   plant     partner Agreement activity   activity   CORE    INDEX8    INDEX2
  Highest level of
  education of manager      0.111a       0.083a   0.052a         0.047a    0.080a  0.092a    0.267a   0.134a    0.110a     0.038c   0.090a   0.111a    0.058a
                            [0.015]     [0.017]   [0.016]       [0.017]   [0.023]  [0.026]  [0.035]  [0.026]    [0.022]   [0.022]   [0.014]  [0.013]   [0.016]
a b
 , , and represent significance at 1%, 5% and 10% respectively
        c




                                                                                                                                                              45

                                       Table 8: Effect of Financing on Firm Innovation ­ Addressing Reverse Causality
Panel A reports instrumental variable regressions while Panel B reports two stage regressions. The first stage regression is External Financing =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3
Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies + 7 Industry Dummies + 8 Country Dummies + 9 Historical Variables (Latitude, Ethnic ,Common Law,
Catholic, Muslim, Protest) OR Average Value of External Financing. The second stage regression in both panels is INDEX8/INDEX2/CORE=  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3
Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies + 7 Industry Dummies + 8 (Predicted Value of External Financing from the First Stage) + 9 Country
Dummies. The second stage regression is estimated using ordinary least squares in Panel A and using ordered logit in Panel B. The variables are described as follows: INDEX8 is an aggregate measure
that is formed by adding 1 if the firm has undertaken any of the ten different innovative activities except Discontinued at least one product (not production) line and Closed at least one existing plant or
outlet. INDEX2 is formed by adding 1 if the firm has Discontinued at least one product (not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation
that is formed by adding 1 if the firm has Developed a new product line or Introduced a new technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Small firms employ 1-19
employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the survey (2000) - year established. Number of establishments is the number of
separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally incorporated and 0 if the firm is organized as a cooperative, sole proprietorship,
partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity utilization levels below 50%, between 50% and 80% and above 80%. External
Financing is the proportion of new investments financed externally and is given by 100-Proportion of new investments financed through internal funds or retained earnings. In columns 1-3, historical
variables are used as instruments. English Common Law is a dummy variable that takes the value 1 for Common Law Countries, Catholic, Muslim and Protest are dummy variables that take the value 1
depending on whether the dominant religious group in the country are Catholics, Protestants, or Muslims respectively, Ethnic Fractionalization is the probability that two randomly selected individuals
in a country do not belong to the same ethnic group. Latitude is the absolute value of the latitude of the country scaled between zero and one. In columns 4-6, the instrument is average external financing
averaged across countries. In columns 7-9, all variables are averaged across countries. In both panels, each specification reports the adjusted R-squares from the first stage regression. Panel A also
reports the p-values of the F-test for the instruments used. Detailed variable definitions and sources are given in the appendix.

Panel A: Instrumental Variables

                                                                                    Average External Financing Across
  Instruments                               Historical Variables                                 Countries                                   Historical Variables

                                     1                 2              3              4              5                 6                7                 8                9
                                                                                                                                CORE               INDEX8           INDEX2
                                                                                                                                (Averaged          (Averaged        (Averaged
                                                                                                                                across             across           across
                               CORE              INDEX8          INDEX2        CORE           INDEX8           INDEX2           countries)         countries)       countries)

  External Financing               0.006a           0.039 a           0           0.006 a        0.039 a              0
                                  [0.002]          [0.005]         [0.001]       [0.002]         [0.005]           [0.001]
  External Financing                                                                                                                0.012 a           0.031 a           0.003
  (Averaged across
  countries)                                                                                                                        [0.004]           [0.008]          [0.002]
  First Stage Adjusted R2          0.2093           0.2088         0.2088         0.209          0.2086            0.2086           0.4676            0.4004           0.4004
  F-Test of Instruments               0                0              0              0              0                 0                0                 0                0
  N                                 9577            9439            9439           9726           9588              9588              44                41               41
a b
 , , and represent significance at 1%, 5% and 10% respectively
         c




                                                                                                                                                                                                        46

Panel B: Two Stage Regressions (OLS in the First Stage, Ordered Logit in the Second Stage)

  Predicted Values in                                                    Average External Financing Across
  Second Stage                          Historical Variables                        Countries                            Historical Variables

                                    1              2             3        4            5               6            7               8              9
                                                                                                             CORE            INDEX8          INDEX2
                                                                                                             (Averaged       (Averaged       (Averaged
  Dependent Variable in                                                                                      across          across          across
  Second Stage               CORE            INDEX8         INDEX2    CORE       INDEX8          INDEX2      countries)      countries)      countries)

  External Financing             0.014a         0.041 a       -0.008   0.014 a       0.041 a        -0.007
                                [0.004]        [0.004]        [0.007]  [0.004]      [0.004]         [0.007]
  External Financing                                                                                             0.118 a         0.134 a        0.003
  (Averaged across
  countries)                                                                                                     [0.029]        [0.033]         [0.002]
  First Stage Adjusted R2        0.2093         0.2088        0.2088    0.209       0.2086          0.2086       0.4676          0.4004         0.4004
  N                              13688          13343         13343    13886         13541          13541          44              41             41
a b
 , , and represent significance at 1%, 5% and 10% respectively
         c




                                                                                                                                                           47

                                                     Table 9: Interaction of Financing with Firm Characteristics
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Corporations +5 Number of Establishments + 6 Capacity utilization Dummies +7
External Financing +8 External Financing X Age + 9 External Financing X Micro/Small Dummy +10 External Financing X State + 11 External Financing X Foreign + 12 External Financing X
Corporations + 13 Industry Dummies + 14 Country Dummies + . The variables are described as follows: GDP per capita is real GDP per capita in US dollars in 2000. Innovation is one of the
following variables: Developed a major new product line, Upgraded an existing product line, Introduced new technology that has substantially changed the way that the main product is produced,
Discontinued at least one product (not production) line, Opened a new plant, Closed at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing
agreement, Outsourced a major production activity that was previously conducted in-house and Brought in-house a major production activity that was previously outsource, INDEX8, INDEX2 and Core.
Each of the first ten innovation indicators is a dummy variable that take the value 1 if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed
by adding 1 if the firm has undertaken any of the ten different innovative activities except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet.
INDEX2 is formed by adding 1 if the firm has Discontinued at least one product (not production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is
formed by adding 1 if the firm has Developed a new product line or Introduced a new technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Firm Size Dummies consist of three
dummies corresponding to small, medium, and large firms. Small firms employ 1-19 employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the
survey (2000) - year established. Number of establishments is the number of separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally
incorporated and 0 if the firm is organized as a cooperative, sole proprietorship, partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity
utilization levels below 50%, between 50% and 80% and above 80%. External Financing is the proportion of new investments financed externally and is given by 100-Proportion of new investments
financed through internal funds or retained earnings. State Ownership is a dummy variable that takes the value 1if the state owns 50% or more of the company and 0 otherwise. Foreign Company is a
dummy variable that takes the value 1 if the foreign private sector owns more than 50% of the company. Logit regressions are used for the individual indicators (columns 1-10) and Ordered Logit
regressions are used for the aggregate indices (columns 11-13). Detailed variable definitions and sources are in the appendix.


                                1            2          3              4              5            6           7            8              9           10            11           12              13
                                                                                                                                                  Brought
                                                                                               Closed                                             in-house a
                                        Upgraded                                               at least    New JV                                 previously
                            New         existing    New          Discontinued     Opened       one         with        New           Outsourced   out-
                            product     product     Techno       at least 1       a new        existing    foreign     Licensing     a major      sourced
                            line        line        logy         product          plant        plant       partner     Agreement     activity     activity       CORE      INDEX8           INDEX2
  Corporations               0.208a       0.181b     0.174b          0.164c         0.128       -0.125       0.22         0.363a         0.122      0.276b         0.216a       0.322a           0.096
                             [0.078]     [0.087]     [0.079]        [0.089]        [0.107]      [0.123]    [0.141]       [0.111]        [0.114]     [0.112]       [0.070]      [0.066]         [0.082]
  External Financing         0.002b       0.002c     -0.001          0.001         0.004a        0.001      0.003b        0.001          0.001      0.002c         0.001        0.002a           0.001
                             [0.001]     [0.001]     [0.001]        [0.001]        [0.001]      [0.001]    [0.001]       [0.001]        [0.001]     [0.001]       [0.001]      [0.001]         [0.001]

  External Financing x          0         0.002       0.001          0.001         -0.001          0        0.001         0.001          0.001      -0.003c        0.001          0              0.001
  Corporations               [0.001]     [0.001]     [0.001]        [0.001]        [0.001]      [0.002]    [0.002]       [0.002]        [0.001]     [0.002]       [0.001]      [0.001]         [0.001]
  Age                        -0.002       -0.003     -0.002          0.004b        -0.013a      0.009a      -0.003        -0.001           0        -0.001         -0.002       0.007a          -0.004a
                             [0.002]     [0.002]     [0.002]        [0.002]        [0.003]      [0.002]    [0.003]       [0.003]        [0.003]     [0.003]       [0.002]      [0.002]         [0.002]
  External Financing         0.003a       0.002b        0            0.001         0.002b       0.002c      0.004a        0.002c        0.002c      0.002c         0.002b       0.001c          0.002a
                             [0.001]     [0.001]     [0.001]        [0.001]        [0.001]      [0.001]    [0.001]       [0.001]        [0.001]     [0.001]       [0.001]      [0.001]         [0.001]
  External Financing x
  Age                           0            0          0              0              0            0           0            0              0        -0.000c          0            0                0
                             [0.000]     [0.000]     [0.000]        [0.000]        [0.000]      [0.000]    [0.000]       [0.000]        [0.000]     [0.000]       [0.000]      [0.000]         [0.000]
  State                      -0.227c     -0.295b     -0.227c         -0.036        -0.530a       0.276     -0.588b        -0.238         -0.06       0.119        -0.264b      -0.343a           0.115
                             [0.131]     [0.132]     [0.133]        [0.153]        [0.192]      [0.178]    [0.230]       [0.166]        [0.210]     [0.205]       [0.117]      [0.109]         [0.137]




                                                                                                                                                                                                     48

                               1           2         3             4         5         6        7        8          9         10       11        12         13
                                                                                                                          Brought
                                                                                   Closed                                 in-house a
                                       Upgraded                                    at least  New JV                       previously
                           New         existing  New         Discontinued Opened   one       with    New       Outsourced out-
                           product     product   Techno      at least 1   a new    existing  foreign Licensing a major    sourced
                           line        line      logy        product      plant    plant     partner Agreement activity   activity   CORE    INDEX8     INDEX2
  External Financing        0.002a       0.002a      0           0.001     0.003a   0.002c    0.003a   0.002a    0.001c     0.001    0.001b    0.002a     0.001b
                            [0.001]     [0.001]   [0.001]       [0.001]   [0.001]  [0.001]   [0.001]  [0.001]    [0.001]   [0.001]   [0.001]   [0.000]    [0.001]

  External Financing x      -0.002       -0.003   -0.002         -0.001    -0.001  -0.007b    0.002   -0.007b     0.004     -0.004   -0.002    -0.003c    -0.003
  State                     [0.002]     [0.002]   [0.002]       [0.003]   [0.003]  [0.003]   [0.004]  [0.003]    [0.003]   [0.004]   [0.002]   [0.002]    [0.002]
  Foreign                   -0.012       0.053    -0.308a          0        -0.08   -0.083    0.737a   -0.11      0.216     0.017    -0.174b   -0.013     -0.044
                            [0.098]     [0.108]   [0.101]       [0.109]   [0.131]  [0.159]   [0.147]  [0.132]    [0.136]   [0.137]   [0.087]   [0.081]    [0.102]
  External Financing        0.002b       0.002a      0           0.001     0.003a   0.002b    0.004a   0.001     0.002b     0.001     0.001    0.002a     0.001b
                            [0.001]     [0.001]   [0.001]       [0.001]   [0.001]  [0.001]   [0.001]  [0.001]    [0.001]   [0.001]   [0.001]   [0.001]    [0.001]

  External Financing x       0.002       0.001    0.005a           0       0.002    -0.002    0.001    0.007a    -0.001     -0.003   0.004a    0.003b        0
  Foreign                   [0.002]     [0.002]   [0.002]       [0.002]   [0.002]  [0.003]   [0.002]  [0.002]    [0.002]   [0.002]   [0.001]   [0.001]    [0.002]
  Micro/Small Dummy         -0.348a     -0.358a   -0.314a       -0.205b   -0.690a  -0.530a   -0.788a  -0.459a    -0.259b   -0.294a   -0.366a   -0.316a    -0.517a
                            [0.076]     [0.087]   [0.076]       [0.083]   [0.100]  [0.116]   [0.130]  [0.105]    [0.103]   [0.104]   [0.068]   [0.077]    [0.064]
  External Financing        0.003a       0.005a   0.002b         0.002c    0.004a   0.001     0.006a   0.004a     0.001     -0.001   0.003a     0.001     0.004a
                            [0.001]     [0.001]   [0.001]       [0.001]   [0.001]  [0.001]   [0.001]  [0.001]    [0.001]   [0.001]   [0.001]   [0.001]    [0.001]

  External Financing x      -0.001      -0.003b   -0.003a        -0.001      0      0.001    -0.003c  -0.003c     0.001     0.002    -0.003a      0       -0.002b
  Micro/Small               [0.001]     [0.001]   [0.001]       [0.001]   [0.001]  [0.002]   [0.002]  [0.002]    [0.001]   [0.001]   [0.001]   [0.001]    [0.001]
a b
 , , and represent significance at 1%, 5% and 10% respectively
        c




                                                                                                                                                               49

                                                    Table 10: Interaction of Competition with Firm Characteristics
This regression model estimated is Innovation =  + 1 Log (GDP/Capita) +2 Firm Size Dummies + 3 Age + 4 Legal Status Dummies +5 Number of Establishments + 6 Capacity utilization
Dummies +7 Percentage of sales sold domestically +8 Percentage of sales sold domestically X Age + 9 Percentage of sales sold domestically X Micro/Small Dummy +10 Percentage of sales sold
domestically X State + 11 Percentage of sales sold domestically X Foreign + 12 Percentage of sales sold domestically X Corporations + 13 Industry Dummies + 14 Country Dummies + . The
variables are described as follows: GDP per capita is real GDP per capita in US dollars in 2000. Innovation is one of the following variables: Developed a major new product line, Upgraded an existing
product line, Introduced new technology that has substantially changed the way that the main product is produced, Discontinued at least one product (not production) line, Opened a new plant, Closed
at least one existing plant or outlet, Agreed to a new joint venture with foreign partner, Obtained a new licensing agreement, Outsourced a major production activity that was previously conducted in-
house and Brought in-house a major production activity that was previously outsource, INDEX8, INDEX2 and Core. Each of the first ten innovation indicators is a dummy variable that take the value 1
if the firm undertook the corresponding innovation and 0 otherwise. INDEX8 is an aggregate measure that is formed by adding 1 if the firm has undertaken any of the ten different innovative activities
except Discontinued at least one product (not production) line and Closed at least one existing plant or outlet. INDEX2 is formed by adding 1 if the firm has Discontinued at least one product (not
production) line or Closed at least one existing plant or outlet. CORE is an aggregate measure of innovation that is formed by adding 1 if the firm has Developed a new product line or Introduced a new
technology. Log (GDP/capita) is the logarithm of GDP per capita in 2000. Firm Size Dummies consist of three dummies corresponding to small, medium, and large firms. Small firms employ 1-19
employees, Medium firms have 20-99 employees, and Large firms have above 100 employees. Age is the year of the survey (2000) - year established. Number of establishments is the number of
separate operating facilities a firm has. Corporations is a dummy variable that takes the value 1 if the firm is legally incorporated and 0 if the firm is organized as a cooperative, sole proprietorship,
partnership or has another legal form. Capacity Utilization Dummies consist of three dummies corresponding to capacity utilization levels below 50%, between 50% and 80% and above 80%.
Percentage of sales sold domestically is the percentage of establishment sales that are sold in the domestic market rather than being exported. State Ownership is a dummy variable that takes the value
1if the state owns 50% or more of the company and 0 otherwise. Foreign Company is a dummy variable that takes the value 1 if the foreign private sector owns more than 50% of the company. Logit
regressions are used for the individual indicators (columns 1-10) and Ordered Logit regressions are used for the aggregate indices (columns 11-13). All Detailed variable definitions and sources are in
the appendix.

                                1            2          3               4            5           6           7             8             9             10          11             12                13
                                                                                                                                                   Brought
                                                                                             Closed                                                in-house a
                                        Upgraded                                             at least    New JV                                    previously
                            New         existing     New          Discontinued    Opened     one         with         New           Outsourced     out-
                            product     product      Techno       at least 1      a new      existing    foreign      Licensing     a major        sourced
                            line        line         logy         product         plant      plant       partner      Agreement     activity       activity      CORE       INDEX8            INDEX2
  Corporations               -0.197c      -0.024      0.239b          -0.074       0.068       0.151      -0.344b        -0.12        -0.201         -0.078       0.042         -0.052            -0.034
                             [0.117]     [0.131]     [0.119]         [0.131]      [0.164]     [0.200]     [0.168]       [0.162]       [0.156]        [0.169]     [0.106]       [0.102]           [0.126]
  Percentage of sales
  sold domestically          -0.003a      -0.003a     -0.001          -0.001       -0.002      0.002      -0.019a       -0.006a       -0.005a        -0.003c     -0.002b       -0.006a              0
                             [0.001]     [0.001]     [0.001]         [0.001]      [0.002]     [0.002]     [0.002]       [0.001]       [0.001]        [0.002]     [0.001]       [0.001]           [0.001]
  Percentage of sales        0.004a       0.003b        0             0.003b         0        -0.003      0.008a        0.005a        0.005a         0.003c       0.002         0.004a            0.002
  sold domestically x
  Corporations               [0.001]     [0.001]     [0.001]         [0.001]      [0.002]     [0.002]     [0.002]       [0.002]       [0.002]        [0.002]     [0.001]       [0.001]           [0.001]
  Age                        -0.003       0.009b      -0.001          0.006       -0.014a     0.011b      -0.016a       -0.007        -0.001         -0.009c      -0.002        -0.004            0.009a
                             [0.003]     [0.004]     [0.003]         [0.003]      [0.005]     [0.004]     [0.005]       [0.005]       [0.004]        [0.005]     [0.003]       [0.003]           [0.003]
  Percentage of sales
  sold domestically          -0.001       0.001         0             0.001       -0.003b      0.001      -0.018a       -0.004a       -0.001         -0.001       -0.001       -0.003a            0.002c
                             [0.001]     [0.001]     [0.001]         [0.001]      [0.001]     [0.002]     [0.002]       [0.001]       [0.001]        [0.001]     [0.001]       [0.001]           [0.001]

  Percentage of sales           0         -0.000a       0               0            0           0        0.000a           0             0              0           0              0                0
  sold domestically x       [0.000]      [0.000]     [0.000]         [0.000]      [0.000]     [0.000]     [0.000]       [0.000]       [0.000]        [0.000]     [0.000]       [0.000]           [0.000]




                                                                                                                                                                                                       50

                         1        2        3          4         5        6        7        8          9         10       11        12         13
                                                                                                            Brought
                                                                     Closed                                 in-house a
                              Upgraded                               at least  New JV                       previously
                     New      existing  New     Discontinued Opened  one       with    New       Outsourced out-
                     product  product   Techno  at least 1   a new   existing  foreign Licensing a major    sourced
                     line     line      logy    product      plant   plant     partner Agreement activity   activity   CORE    INDEX8     INDEX2
Age

State                  0.417     0.22    0.084      0.361     -0.219  0.774b    -0.328  -0.829b    0.790b      0.37     0.23      0.166     0.673b
                      [0.268]  [0.285]  [0.267]    [0.287]   [0.367]  [0.330]  [0.342]  [0.370]    [0.347]   [0.374]   [0.239]   [0.238]    [0.262]
Percentage of sales
sold domestically        0      -0.001   -0.001     0.001c   -0.002c     0     -0.015a  -0.003a    -0.001       0      -0.001    -0.002a    0.002b
                      [0.001]  [0.001]  [0.001]    [0.001]   [0.001]  [0.001]  [0.001]  [0.001]    [0.001]   [0.001]   [0.001]   [0.001]    [0.001]
Percentage of sales   -0.009a  -0.008b  -0.005c    -0.006c    -0.005  -0.007b   -0.002   0.005     -0.011a    -0.005   -0.007a   -0.008a    -0.008a
sold domestically x
State                 [0.003]  [0.003]  [0.003]    [0.003]   [0.004]  [0.004]  [0.004]  [0.004]    [0.004]   [0.004]   [0.003]   [0.003]    [0.003]
Foreign                0.032    -0.055   0.109      0.066     -0.252  -0.398c   -0.145   -0.091    -0.016      0.02     0.064     0.07       0.009
                      [0.122]  [0.140]  [0.123]    [0.135]   [0.166]  [0.224]  [0.169]  [0.164]    [0.154]   [0.167]   [0.111]   [0.104]    [0.130]
Percentage of sales
sold domestically        0      -0.001     0        0.002c   -0.003b  -0.001   -0.017a  -0.004a    -0.001       0         0      -0.002a    0.001c
                      [0.001]  [0.001]  [0.001]    [0.001]   [0.001]  [0.001]  [0.001]  [0.001]    [0.001]   [0.001]   [0.001]   [0.001]    [0.001]
Percentage of sales    0.001    0.003    -0.001       0       0.005b   0.003    0.012a   0.004c    0.003c     -0.002      0       0.001     -0.001
sold domestically x
Foreign               [0.002]  [0.002]  [0.002]    [0.002]   [0.002]  [0.003]  [0.002]  [0.002]    [0.002]   [0.002]   [0.001]   [0.001]    [0.002]
Small/Medium
Dummy                 -0.218c  -0.280b  -0.561a    -0.218c   -0.294c  -0.582a   0.164    -0.252     0.116     0.133    -0.466a   -0.349a    -0.318a
                      [0.112]  [0.125]  [0.114]    [0.127]   [0.160]  [0.205]  [0.161]  [0.160]    [0.148]   [0.161]   [0.102]   [0.098]    [0.122]
Percentage of sales
sold domestically        0      -0.001  -0.002b     0.002     -0.001  -0.001   -0.010a  -0.002c       0       0.001    -0.002c   -0.002a     0.001
                      [0.001]  [0.001]  [0.001]    [0.001]   [0.001]  [0.002]  [0.002]  [0.001]    [0.001]   [0.001]   [0.001]   [0.001]    [0.001]
Percentage of sales   -0.003c   -0.002   0.001      -0.002   -0.005a     0     -0.011a   -0.003    -0.005a   -0.005a   -0.001    -0.003b    -0.001
sold domestically x
Small/Medium          [0.001]  [0.001]  [0.001]    [0.001]   [0.002]  [0.002]  [0.002]  [0.002]    [0.002]   [0.002]   [0.001]   [0.001]    [0.001]




                                                                                                                                                 51

Figure 1: Sources of External Financing Used by Firms of Different Size Groups and Innovation Types

                        100%




                         80%




                                                                                                                           Other
                                                                                                                           Informal
   (%)                   60%                                                                                               Family
                                                                                                                           Equity
                                                                                                                           Creditcard
                                                                                                                           Tradecredit
      Financing
                                                                                                                           InvFund
                                                                                                                           Leasing
               ernal
                         40%                                                                                               Foreign Bk
                    Ext                                                                                                    Local Bk
                                                                                                                           Internal




                         20%




                          0%
                               Small0    Small1    Small2    Med0       Med1         Med2    Large0    Large1    Large2

                                                                 Firm Size-Innovation




                                                                                                                                         52

                                                             Appendix A1: Variable Definition and Sources


            Variable                                                                 Definition                                                 Source

Innovation Indicators

New product line                   Has your company developed a new product line in the last three years? Yes (1) No (0)                        Investment Climate Survey


Upgraded existing product line     Has your company upgraded an existing product line in the last three years? Yes (1) No (0)                   Investment Climate Survey
                                   Has your company introduced new technology that has substantially changed the way that the main
New Technology                     product is produced, in the last three years? Yes (1) No (0)                                                 Investment Climate Survey

                                   Has your company discontinued at least one product (not production) line in the last three years? Yes (1)
Discontinued at least 1 product    No (0)                                                                                                       Investment Climate Survey


Opened a new plant                 Has your company opened a new plant in the last three years? Yes (1) No (0)                                  Investment Climate Survey


Closed at least one existing plant Has your company closed at least one existing plant or outlet in the last three years? Yes (1) No (0)        Investment Climate Survey


New JV with foreign partner        Has your company agreed a new joint venture with a foreign partner in the last three years? Yes (1) No (0)   Investment Climate Survey


New Licensing Agreement            Has your company obtained a new licensing agreement in the last three years? Yes (1) No (0)                  Investment Climate Survey

                                   Has your company outsourced a major production activity that was previously conducted in-house in the
Outsourced a major activity        last three years? Yes (1) No (0)                                                                             Investment Climate Survey

Brought in-house a previously      Has your company brought in-house a major production activity that was previously outsourced in the last
out-sourced activity               three years? Yes (1) No (0)                                                                                  Investment Climate Survey
Aggregate Innovation Indicators
                                   An aggregate measure of firm innovation that is formed by adding 1 for each of the following cases: if the
                                   firm has developed a new product line, upgraded an existing product line, introduced new technology,
                                   opened a new plant, signed a new joint venture with a foreign partner, obtained a new licensing agreement,
                                   outsourced a major production activity or brought in-house a previously outsourced activity in the past
INDEX8                             three years. The Index ranges from 0 to 8 with 8 indicating the firm is most innovative.                     Own Calculations
                                   An aggregate measure of firm innovation that is formed by adding 1 if the firm has discontinued at least
                                   one product, or closed at least one existing plant. The Index ranges from 0 to 2 and is meant to capture
INDEX2                             activities that do not require external financing                                                            Own Calculations
                                   An aggregate measure of innovation that is formed by adding 1 if the firm has developed a new product
                                   line or introduced a new technology. The Index ranges from 0 to 2 and is meant to capture activities
CORE                               constitute core innovation                                                                                   Own Calculations

                                   Firm Size Dummies consist of three dummies corresponding to small, medium, and large firms. Small
Firm Size Dummies                  firms have 1-19 employees, Medium firms have20-99 employees, Large firms have over 100 employees.            Investment Climate Survey




                                                                                                                                                                             53

             Variable                                                              Definition                                                  Source


Number of establishments         The number of separate operating facilities of a firm.                                                        Investment Climate Survey


Age                              Age is the year of the survey (2000) - year established                                                       Investment Climate Survey

                                 Corporations is a dummy variable that takes the value 1 if the firm is organized as a corporation and 0 if
Corporations                     the firm is organized as a Cooperative, Sole Proprietorship or Partnership or some other legal form.          Investment Climate Survey
                                 Capacity Utilization Dummies consist of three dummies corresponding to the establishment's average
                                 capacity utilization levels below 50%, between 50% and 80% and above 80%, over the last year. Capacity
                                 utilization is defined as the amount of output actually produced relative to the maximum amount that could
Capacity Utilization Dummies     be produced with the firm's existing machinery and equipment and regular shifts.                              Investment Climate Survey
Competition

                                 Number of competitors is the total number of competitors in the domestic market that are private domestic
Number of Competitors            enterprises, state-owned enterprises or foreign-owned enterprises.                                            Investment Climate Survey
Percentage of sales sold
domestically                     Percentage of establishment sales that are sold in the domestic market rather than being exported.            Investment Climate Survey
                                 Considering the main product line or main line of services and comparing the production process with that
                                 of the firm's closest competitor, the following best summarizes the firm's position about its technology:
Firm's technology compared to    Less advanced than that of its main competitor (1); About the same as that of its main competitor (2); More
competitor                       advanced than that of its main competitor                                                                     Investment Climate Survey

Does the firm have a foreign     Dummy variable that takes the value 1 if over the last year, in the company's main product line, the firm
competitor?                      had at least one foreign owned firm as a competitor.                                                          Investment Climate Survey

Does the firm have a state       Dummy variable that takes the value 1 if over the last year, in the company's main product line, the firm
competitor?                      had at least one state owned firm as a competitor.                                                            Investment Climate Survey
Foreign Competition had greatest Dummy variable that takes value 1 if foreign competition had the greatest influence on the firm to reduce
influence to reduce production   production costs of existing products and services and 0 if greatest influence instead was domestic
costs                            competition, customers, creditors, shareholders or government agencies.                                       Investment Climate Survey
Foreign Competition had greatest Dummy variable that takes value 1 if foreign competition had the greatest influence on the firm to develop
influence to develop new         new products or services and markets and 0 if the greatest influence was domestic competition, customers,
products                         creditors, shareholders or government agencies instead.                                                       Investment Climate Survey

Human Capital                                                                                                                                  Investment Climate Survey

Top Mgr's total years of         How many years of experience working in this sector did the top manager have before running this
experience                       establishment?                                                                                                Investment Climate Survey

                                 Dummy variable that takes the value 1 if the top manager has had between 3-10 years of experience
Mid-level experience             working in this sector before running the establishment                                                       Investment Climate Survey

                                 Dummy variable that takes the value 1 if the top manager has had more than 10 years of experience
Highly experienced               working in this sector before running the establishment                                                       Investment Climate Survey


Skilled foreign workers          Percentage of permanent skilled workers that are foreign nationals                                            Investment Climate Survey




                                                                                                                                                                            54

             Variable                                                             Definition                                                  Source

% workforce with >12 yrs years
education                       Percentage of workforce that has more than 12 years of education defined as university or higher.             Investment Climate Survey
                                Highest education level of the manager takes values 1 to 6 according to the following categories-did not
Highest level of education of   complete secondary school (1), secondary school (2), vocational training (3), some university training (4),
manager                         graduate degree (5) and post graduate degree (6)                                                              Investment Climate Survey
Ownership                                                                                                                                     Investment Climate Survey

                                State Ownership is a dummy variable that takes the value 1if the state owns 50% or more of the company
State Ownership                 and 0 otherwise.                                                                                              Investment Climate Survey

                                Domestic Company is a dummy variable that takes the value 1 if the domestic private sector owns 50% or
Domestic                        more and takes the value 0 if the foreign private sector owns 50% or more.                                    Investment Climate Survey

                                Foreign Company is a dummy variable that takes the value 1 if the foreign private sector owns 50% or
Foreign                         more and takes the value 0 if the domestic private sector owns 50% or more.                                   Investment Climate Survey
                                Individual, Family, Financial Institution, Managers, Employees and Domestic Corporation are dummy
Identity of the Controlling     variables which take the value 1 if the largest shareholder or owner in the firm is an individual, family,
Shareholder                     bank or investment fund, manager of the firm, employees of the firm, or domestic corporation                  Investment Climate Survey

External Financing                                                                                                                            Investment Climate Survey


External Financing              100-Percentage of new investment over the last year coming from internal funds or retained earnings           Investment Climate Survey


Equity                          Percentage of new investment over the last year coming from equity, sale of stock                             Investment Climate Survey


Local Bank                      Percentage of new investment over the last year coming from local commercial banks (loan, overdraft)          Investment Climate Survey


Foreign Bank                    Percentage of new investment over the last year coming from foreign owned commercial banks                    Investment Climate Survey


Leasing                         Percentage of new investment over the last year coming from leasing arrangement                               Investment Climate Survey

                                Percentage of new investment over the last year coming from investment funds/special development
Investment Fund                 financing or other state services                                                                             Investment Climate Survey


Trade Credit                    Percentage of new investment over the last year coming from supplier or customer credit                       Investment Climate Survey


Credit Card                     Percentage of new investment over the last year coming from credit cards                                      Investment Climate Survey


Family                          Percentage of new investment over the last year coming from family and friends                                Investment Climate Survey


Informal                        Percentage of new investment over the last year coming from informal sources (eg: moneylender)                Investment Climate Survey




                                                                                                                                                                           55

            Variable                                                              Definition                                             Source


Other                          Percentage of new investment over the last year coming from other sources                                 Investment Climate Survey

Share of borrowing in foreign
currency                       Percentage share of total borrowing (loans, accounts payable) that is denominated in foreign currency?    Investment Climate Survey


Necessity of collateral        Did the financing require collateral or a deposit? Yes (1) No (0)                                         Investment Climate Survey

Historical Instruments

                               English Common Law is a dummy variable that takes the value 1 for Common Law Countries and 0 for          La Porta, Lopez-de-Silanes, Shleifer and
English Common Law             Civil Law and Socialist Law Countries                                                                     Vishny (1999)

                                                                                                                                         La Porta, Lopez-de-Silanes, Shleifer and
Catholic                       Dummy Variables that takes the value 1 if the dominant religious group in the country are Catholics       Vishny (1999)

                                                                                                                                         La Porta, Lopez-de-Silanes, Shleifer and
Muslim                         Dummy Variables that takes the value 1 if the dominant religious group in the country are Muslims         Vishny (1999)

                                                                                                                                         La Porta, Lopez-de-Silanes, Shleifer and
Protest                        Dummy Variables that takes the value 1 if the dominant religious group in the country are Protestants     Vishny (1999)

                               Ethnic Fractionalization is the probability that two randomly selected individuals in a country do not    Alesina et al. (2003)
Ethnic Fractionalization       belong to the same ethnic group
                                                                                                                                         La Porta, Lopez-de-Silanes, Shleifer and
Latitude                       Latitude is the absolute value of the latitude of the country scaled between zero and one.                Vishny (1999)




                                                                                                                                                                                  56