Financial Development and Innovation: The Role of Market Structure*

Abstract

AbstractWe assess how financial development affects innovation. For this purpose, we employ a unique Research Quotient data set from 1980 to 2018, and observe significant inverted‐U effects of financial development on innovation for equity and credit markets. Specifically, the effects of the markets are sector‐specific, implying that the inverted‐U effect of the equity market on innovation is mainly driven by its diminishing effect on innovation in high‐technology industries, while credit markets mostly affect innovation in non‐high‐technology industries. Regarding the mechanism, we posit that the inverted‐U shape between finance and innovation may be explained by the disproportionate funds allocation‐induced market concentration.