Firm innovation and covenant tightness

Abstract This study explores the association between firm innovation and loan covenant strictness. We find that lenders construct stricter contracts for firms filing more patents, consistent with imposing oversight on when they enter commercialization stage after having demonstrated their inventiveness. Our results hold under propensity score matching entropy balancing, exploiting American Inventors Protection Act as a shock affecting unrelated banks’ access to patent information. The relationship we document is stronger lender has expertise higher default risk. demonstrate borrowers’ filings are associated future R&D capital investment likelihood of acquiring in industry filings. theoretical prediction interpret indicative high inventive potential requires discipline by order be converted into actual business success, them designing debt contract terms accordingly.