This paper investigates the relationship between profit efficiency, finance and innovation. By adopting stochastic frontiers, we pioneer the use of a novel dataset merging firm level survey data with balance sheet information for a large sample of
European companies. We find that firms having difficulties in access to finance as
well as firms introducing product innovation display an incentive to improve their
efficiency. While innovation produces benefit for firms’ profitability, financial constraints impose a discipline to the firms forcing them to cut unproductive costs that
reduce the profitability. We document nuanced differences between firms in industry
and services, while they are more pronounced when we look at disaggregation
across High-Tech and Low-Tech companies. From a policy perspective, our results
enrich the understanding on the link between innovation, financial constraints and
efficiency, which goes beyond the idea that easier access to finance is the panacea to
get higher performance.
