THE EFFECT OF FINANCIAL CONSTRAINTS ON INNOVATION AND FIRM GROWTH: EVIDENCES FROM ETHIOPIA

Abstract

The purpose of this paper is to investigate the effect of financial constraints on innovation and firm growth in Ethiopia. It also examines how the effect of financial constraints varies by the main firm characteristics such as size, age and sector. The study utilized firm-level data from World Bank Enterprise Survey of 2015 for the fiscal year 2012-2014. 770 firms have been included in the sample in Ethiopia. Quantitative research approach and explanatory research design was used. Probit regression model was used to investigate effect of financial constraint on firm’s product and process innovation. The Multiple linear regression models were used to examine the effect of financial constraints on firm’s growth in Ethiopia. Stata version 14 was used to analyze the data and estimate the model parameters.

The result from the probit regression analysis reveals that firms that face financial constraints are less likely to introduce any innovational activities and it also reduces the firm’s growth. Firms that have larger number of full-time employees are not affected by financial constraints and are more likely to introduce any new or improved products without being affected by the financial constraint. Similarly, firms that invest on R&D and human capital are more likely to introduce new or improved products and process (TPP). Across manufacturing and service sector firms that have financial constraints are less likely to introduce any improved product or improved process (TPP).Financial constraint adversely affect the manufacturing sector than the service sector at 5% level of significant with a p-value of 0.000. Also research and development and human capital significantly positively affect both sectors.

Having the analyses on the variables the study recommends different stakeholders to apply sensible strategy in order to reduce the financial constraints by improving budget utilization, enhancing project study capacity, increasing information systems, and well maintained, clear property records to facilitate collateralization.