financial market and innovation

Paper to be presented at the Summer Conference 2010 on "Opening Up Innovation: Strategy, Organization and Technology" at Imperial College London Business School, June 16 - 18, 2010

FINANCIAL MARKET AND INNOVATION Hartmut Hirsch-kreinsen TU Dortmund [email protected]

Abstract: This contribution addresses the relationship between technological innovation and finance. The financial market must be regarded as one of the fundamental prerequisite of innovation, inasmuch as it is here that decisions are made on capital allocation to enterprises. Firstly, it is asked which interdependencies can be detected between the institutionalised conditions of the financial market and the innovation strategies pursued by the enterprises? Secondly, it is asked which country-specific patterns of interdependencies can be distinguished? Thirdly, the consequences of the recently observable internationalisation of the financial market and of corporate financing in countries with so-called Coordinated Market Economies such as Germany are discussed and, finally, first thoughts on the repercussions of the international credit crunch on innovations will be presented. The paper is based on an extensive literature research in the fields of economic sociology and innovation studies and the analysis of the public debate on the prospects of the current economic development.

JEL - codes: P5, P, -

Financial Market and Innovation ?????????

Paper submitted to the DRUID Summer Conference 2010 London, June 16 - June 18, 2010

Draft paper

February 2010 ????????

2

1. Introduction This contribution addresses the relationship between technological innovation and finance. Therewith it delves into the interaction between central structural characteristics and development moments of capitalist societies, an aspect which has so far been analysed only marginally in the social theory debate on the dynamics and transformation of capitalism as well as in socioscientific innovation research (cf. Gerybadze, 2004; O’Sullivan, 2005). It is indisputable that innovations can be regarded as an essential driving force of capitalist development. This is equally emphasised in the greatly differing theoretical concepts from Marx to Sombart to Schumpeter (cf. Fagerberg, 2005). Technological innovations are regarded as the mainspring of economic dynamics, also for the current historical development phase. The reasons for this are well-known: Innovations are considered to be the central starting point for the protection of jobs and the stimulation of growth; it is believed that only the constant improvement of their innovation ability enables the advanced countries to hold their own in the global competition; an example for this is the “Lisbon Agenda” of the EU. The socioscientific debate, which can be subsumed under the well-known terms ”knowledge economy“ and “knowledge society”, argues similarly (e.g. Drucker, 1994; Stehr, 1994; Willke, 1998; David/Foray, 2003). Furthermore the scientific debate emphasises that the course and the scope of technological innovations correlate with the given social-institutional conditions. This is instructively shown by innovation studies that, in an attempt to explain diverging innovation patterns, examine different kinds of innovation systems from the perspective of institution theory. The key idea here is that the different social-institutional arrangements, which vary not only in the different countries but also in sectors and regions, shape the process of technological innovations. In this connection, the concept of “national innovation systems“ with its many variations has gained particular scientific and political prominence (cf. Lundvall, 1992; 2007 Nelson, 1993; Edquist, 2005). Similar key ideas can be found in the work of institution theory-based governance research, for instance in the concept of ‘social systems of production and innovation’ (cf. Hollingsworth/Boyer, 1997; Hollingsworth, 2000; Amable/Petit, 2001). This research points to the significance of institutional factors such as the scientific system, the educational system and the labour market, industrial relations and the financial sector, which in the interplay with the structures and strategies of relevant organisations (in particular of enterprises) shape the focus areas and process of innovation. These studies reveal, on the one hand, that the interplay of all of the institutional factors that shapes an innovation system and the therein embedded corporate strategies. On the other hand, the

3 literature points to the fact that the financial market must be regarded as a fundamental structural condition of the capitalist method of production and innovation, inasmuch as it is here that decisions are made on capital allocation to enterprises. 1 As is shown not only by international comparative studies on systems of innovation but also by economic history studies (e.g. Gerschenkron, 1966; Zysman, 1983; Albert, 1991), the different conditions of the financial markets decisively shape “the logic of the whole political economy“ (Lane, 2003: 80). More specifically, the different financial market conditions entail different forms of corporate financing, specific patterns of the system of corporate governance as well as divergent latitudes for enterprise strategies. 2 However, less has been written on the interdependencies between the patterns of corporate finance and governance on the one hand and company innovation strategies on the other hand (cf. O’Sullivan, 2005). In the context of Anglo-Saxon “innovation studies“, there are a few publications with an international and historical comparative perspective that examine the link between different forms of financing and the process of innovations. Particular mention must be made of the extensive international comparative studies of Andrew Tylecote, Paulina Ramirez et al., in which the consequences of the structural differences between the US and the UK were systematically analysed (cf. Tylecote/Conesa, 1999; Perez, 2002; Tylecote et al., 2002; Tylecote/Ramirez 2006). Furthermore, William Lazonick (Lazonick/O’Sullivan, 1996; Lazonick, 2003, 2007) delves into the connection between the (likewise) Anglo-Saxon financial market conditions and the structural characteristics of an innovative enterprise, in particular with regard to innovations in high-tech sectors. These studies show the following: Firstly, not only the process and the various phases of technological innovations but also the different economic sectors are linked to specific financing requirements and forms of financing; secondly the international comparative perspective reveals differing financial market and innovation constellations; thirdly they point to structural divergences between the conditions of the financial market and the requirements of technological innovations. The hypothesis that financial market conditions retard rather than promote innovations has been put forward on several occasions (cf. Lazonick, 2003).

1

The term “financial market” is used to subsume the different subsectors of debt and equity financing of private and public investments. The stock markets with their influential actors, such as investment funds, analysts and rating agents are considered to be the steering centres (Huffschmid, 1999; Windolf, 2005).

2

The term “system of corporate governance“ is here taken to mean the complex of structures, interests and practices which governs and controls the enterprises and their strategies; basically this refers to the prevailing ownership structures and the associated entrepreneurial objectives as well as the rules of decision-making in the corporate management.

4 The following argumentation takes up these debates and open questions: To begin with, it is asked which interdependencies can be detected between the institutionalised conditions of the financial market and the innovation strategies pursued by the enterprises? Secondly, it is asked which country-specific patterns of interdependencies can be distinguished? Thirdly, the consequences of the recently observable internationalisation of the financial market and of corporate financing in countries with so-called Coordinated Market Economies such as Germany are discussed and, finally, first thoughts on the repercussions of the international credit crunch on innovations will be presented. The following argumentation is based on an extensive literature research in the fields of economic sociology and innovation studies and the analysis of the public debate on the prospects of the current economic development. Therefore the paper does not present final research findings but rather puts reflections from research in progress up for discussion. 2. Innovation and finance – challenges and requirements a) The problems of financing innovation Hereafter, the term ‘innovation’ is taken to denote technological innovations, i.e the genesis, development and diffusion of new marketable products, services and technico-organisational processes. In other words: Innovation can be characterised as ”new creations of economic significance of material or intangible kind. They may be brand new but are often new combinations of existing elements“. (Edquist, 2001: 25) Prominent features of technological innovation are their uncertainty with regard to the attainable technical and economic success, the risks of the usually fairly unpredictable course over time of the innovation process with its ex ante almost incalculable intermediate steps and unexpectedly arising decision-making situations and, finally, the difficulty to predict innovation costs (cf. O’Sullivan, 2005; Lazonick, 2007). A further central feature of technological innovation is the intangible nature of its assets, i.e. the companies’ specific knowledge base and work organisation. The importance of human capital for innovation activities can be regarded as maximal, since the employees embody the knowledge as long as it is not made tangible. This knowledge is mostly described as uncodified, tacit and cumulative in character (cf. Dosi, 1990; Deligia, 2005). However, innovations differ greatly from each other, depending on the technology field, the phase they are in, their focus and objectives as well as their scope (cf. Fagerberg, 2005). These different innovation types are linked to likewise varying social situations, for instance differing requirements regarding effectiveness and efficiency, different organisational patterns over time and different constellations of involved actors. At the beginning of a new project, for example, there is often a high degree of uncertainty and many obstacles have to be overcome on

5 a yet unknown development path (Deligia, 2005). Radical innovations in particular often challenge given economic and institutional systems and change them in ways that are not foreseeable but can at best be rationally reconstructed ex post. The actor who initiates this process, who carries out “new combinations“ and thus practices “creative destruction“ and who lets himself in for the associated uncertainties and, if successful, realises a monopoly profit, is - in Schumpeter’s terminology – the “dynamic entrepreneur“. The special character of innovations entails specific requirements regarding their financing. In a nutshell: ”Innovation is an expensive process; significant resources must be expended to initiate, direct and sustain it. It is a process that takes time, which means that the resources that support it must be committed until the process is complete. Finally, its outcomes are uncertain so the returns to innovative investments are not assured.” (O’Sullivan, 2005: 240) If one tries to qualify the reciprocal connection between innovations and financing, one has to assume a structural contradiction between the two: The logic of the financial market and its actors, that aim at return on investment, presses for as extensive as possible a calculability of future situations and investment alternatives. The goal is to achieve a maximisation of security of expectations regarding the future yield of different capital investment opportunities, in order to be able to make a well-founded choice of that opportunity that does not only have the highest but also as secure as possible a return. In this logic of rational calculation of investment opportunities and expected yields, investments in innovation always compete with alternative forms of investments and therefore must have a calculable economic advantage that can moreover be realised within a time frame regarded as reasonable (Kline/Rosenberg, 1986). A typical representative of this logic is the figure of the “rent-seeker“ who is interested in high, recurring and probably also rapid returns on the capital employed and who usually avoids investment risks or at best expects a high renumeration for incurring such risks. This figure with a homo oeconomicus rationality directed at calculability is, however, not necessarily compatible with that of the “”dynamic entrepreneur”. b) The innovation dilemma The characteristics of the innovation and of the financial market logic, resp. the interests and strategies of the actors diverge structurally. Innovation research speaks of the “innovation dilemma“ (cf. Rammert, 1988; Dosi, 1990). On the one hand, a strict subordination of innovation activities to economic calculations impedes innovation and only strings of small and pseudo-innovations are brought about. On the other hand, the too extensive autonomy of innovation processes proves to be a cost-generating that poses a threat to the existence of the companies and the rent-seeking

6 interests of the financers (Rammert, 1992: 11). In this dilemma the concurrence of security of expectations and of uncertainty manifests itself, a fact which cannot be circumvented by capitalistic societies, as Jens Beckert has recently pointed out. On the one side, modern capitalism is based on an as exact as possible calculability of all economic processes by means of a successive standardisation and systematisation. On the other side, however, capitalist economies are characterised by a constantly renewed uncertainty which results directly from its innovation dynamics. Both aspects are inextricably interwoven. Innovation dynamics with their accompanying “creative destruction“ of existing structures do not only generate new profit opportunities which act as incentive for producing for an anonymous market, but also new uncertainties that have to be reduced by the means and methods of rational calculation (Beckert, 2007: 307). Economic theory too emphasises the fact that this correlation represents a structural problem (cf. Gerybadze, 2004: 290). Of central importance is the reference to the asymmetric information between the innovator and the financier, which can lead to moral hazard on the part of the innovator and to adverse selection on the part of the financier. This ‘asymmetric information‘ hypothesis relates to the fact that an innovator who tries to launch a new product or process is likely to have a better understanding of the probabilities of success of his initiative than an external financier. Since the uncertainty regarding the potentials of a long-term oriented, R&D-based project is necessarily higher than that of an ordinary investment, the additional premium required by an investor as a consequence of the asymmetric information problem will be correspondingly higher. In addition, firms are reluctant to reveal the details of their innovative projects for fear that their knowledge could be disclosed to their competitors with potentially costly consequences (Deligia, 2006: 82). Therefore, according to Giovanni Dosi, the financier always needs “…some sort of heroic trust in unexplored opportunities. In this respect, the optimistic irrationality of Schumpeterian entrepreneurs requires a symmetric counterpart amongst bankers.” To support economic dynamics, a financial system must allow for the possibility of numerous gambles on unexplored opportunities, about which little is known ex ante, but which can reasonably be expected to be, on average, failures (Dosi, 1990: 307). 3. Country-specific relations between innovation and finance The innovation dilemma can be theoretically regarded as a coordination problem of actors with divergent interests and strategies. Due to existing social-institutional conditions and the prevailing pattern of “embeddedness” of innovative action this coordination problem can be solved in different ways. It can be shown in an international comparative perspective, that the financing problems of innovation have been overcome in different country and time-specific ways. Consequently, different

7 innovation patterns prevail in different counties and historic periods. In this perspective one can refer to the prominent Varieties of Capitalism approach and its differentiation between Liberal Market Economies (LME), typically the US, and Coordinated Market Economies (CME), typically Germany or France. According to this, the predominant innovation pattern in liberal market economies is that of radical innovations in new and fast-developing technology fields, while in co-ordinated market economies quality-oriented incremental innovation in established technology areas tend to prevail (Hall/Soskice, 2001; Deeg/Jackson, 2006). Accordingly, new industries such as IT and biotechnology are seen to play a very large role in the US and to generate completely new products within short time spans. In Germany on the other hand, traditional industries such as the chemical and the metalworking industries and mechanical engineering and automotive industry, that pursue incremental product development at a high technical level, dominate. The structural conditions that are in each case typical for these two production systems, such as the R&D -systems, the education and vocational training systems, the industrial relations, the financial markets and the corporate structures, are regarded as important parameters for these different innovation patterns (cf. Hollingsworth, 2000). As already mentioned, the special role of the financial market and the forms of financing of innovation are, however, not taken into account. If one summarises the findings of the few special research studies on this issue, the following country -specific conditions become apparent: 3 a) Insider-dominated system The technologically sophisticated incremental innovations in mechanical engineering and the automotive industry, which are typical for the German industry, are seen to be linked with forms of financing that are characterised by external financing and a therewith associated long-term orientation of the credit grantors. The institutional context is a system of networked corporate governance dominated by universal banks and industrial cross ownership (see e.g. Streeck, 1991; 1997). In the literature, this system is referred to as “insider-dominated“ (Tylecote/Ramirez, 2006) or “relationship-based“ (Rajan/Zingales, 2001). A prominent feature of this system is a high degree of enterprise-oriented commitment of external capital providers and their relatively detailed knowledge on the situation and the activities of the enterprises they finance (cf. Dosi, 1990; Tylecote/Conesa, 1999; Hall/Soskice, 2001). The dominant means of financing of firms and thus of innovations is the loan from the firm´s bank. Hence a specific form of economic rationality results: It is not in the 3

The fact that in a historical perspective various forms of solutions for the financing problems of innovations were found within the different national contexts is for the moment neglected here. On the long-term development in the US, see, for example, the research study of Perez (2002) and the bibliography in O’Sullivan (2005); for a differentiated analysis see also Block (2002).

8 interest of the lending banks that their debtors, i.e. the enterprises, pursue short-term strategies of profit maximisation and thus take risks regarding their long-term existence; if these are avoided, the repayment of the loans and the profits of the creditor banks are assured. Paul Windolf (2005: 22) describes this in the following words: “The loans of the banks were patient, controlling and riskaverse capital“. Quantitatively speaking, long-term bank loans have been the dominant form of financing in the manufacturing industry since the mid-1990s due to the limited equity of the enterprises (Vieweg, 2001: 53). With regard to the innovation processes, this implicates a strong and long-term commitment of external capital providers to an innovating company on the basis of a relatively exact knowledge of the processes that have to be financed. Dosi argues that enduring learning processes between the involved actors are characteristic for these innovation and that the role of the investors is based on “participation” and “voice” (Dosi, 1990). This also implicates that the investors‘ access to the free cash flow of the companies is limited. In other words, the management can dispose of internal funds for innovation decisions. Consequently, innovation with a long-term perspective proceed incrementally along rather established technological trajectories, as the accumulated skills of the involved actors and the well-oiled organisational routines in the context of the long-term oriented relations are prejudicial to radical innovations and their risks and uncertainties. In this regard firms that work on radical innovation are at a disadvantage because, given these financing modalities, the availability of risk-oriented venture capital for such innovation strategies is limited (e.g. Caspar et al., 1999). b) Outsider-dominated system In contrast, the prominence of high-tech-oriented radical innovations, typical for instance for the US, is seen in close conjunction with market-regulated financing conditions. The basis here is capital market financing, the central instrument is the share which goes hand in hand with a high degree of flexibility and willingness to take risks. With respect to concrete innovation patterns, however, one must differentiate between two segments of the financing system: The one segment is based on a financing system, in which the economic objectives of the firms and their investors centre on a shortterm profit maximisation and on an as high as possible share price. The main players of the financial market in this respect are pension funds, insurance companies, mutual funds and the “asset management houses“, which manage investment portfolios. These organisations are likely to own shares in several firms of a sector, and thus to have a general understanding of the sector as a whole as a precondition for their investment decisions. An important role is also played by private equity firms which invest in large control-oriented equity stakes on behalf of other financial

9 institutions such as pension funds (Tylecote/Ramirez, 2005: 12). It is characteristic of this subsystem that the close integration of investors and individual enterprises, which is in many cases the prerequisite for corporate financing in Germany, is lacking. Instead, successful corporate financing hinges upon the public proof of the profitability of the company activities (Hall/Soskice, 2001). The basis for this are – frequently standardised – cost accounting methods which abstract from the concrete context of a company and its activities. This form of corporate financing and of corporate governance is also labeled “outsider-dominated“ system. Its “arms-length relationships“ are characterised by only loose commitments to enterprises and a high pressure for shareholder value (Tylecote/Ramirez, 2006). With regard to innovation processes, this implicates a loose commitment

of external capital providers to an innovating company on the basis of a low company and industryspecific expertise. The strategies of the investors are seen as selection processes based on “entry” and “exit-mechanisms” (Dosi, 1990). Tylecote and Ramirez summarise the consequences for innovation strategies as follows: “…R&D intensity will not be a positive function of pressure for shareholder value, but rather a negative one, at least where engagement or industry-specific expertise are low…shareholders who do not understand the value of spending on innovation…will impose short-term pressure which discourage it.” And they go on to say: “Moreover, innovation which promises a return somewhat less than the cost of capital will certainly be discouraged by pressure for shareholder value – whereas a management free of such pressure will favour it…” (Tylecote/Ramirez, 2005: 27). Innovation in established firms therefore usually proceed with a shortterm orientation, aim at rapid economic successes and develop the available technologies at a very slow pace. Evidence for this is the decades-long dominance of traditional manufacturing technologies in the U.S. (cf. Hirsch-Kreinsen, 1992) and the not advanced automotive technology of American automotive manufacturers. The prominence of high-tech oriented radical innovation in this innovation system can primarily be put down to the existence of a second, institutionalised segment of the financial market for risk and innovation-oriented venture capital. The driving power is the high availability of risk-oriented capital. Venture capital can be regarded as a subset of private equity that is invested in new or young firms in high growth mode, usually high-technology sectors pursuing risky innovation strategies. In the U.S., venture capital is basically responsible for the remarkable rise in the proportion of R&D performed by firms with less than 500 employees, with an increase from 5.9% in 1984 to 20.7% in 2003 (Tylecote/Ramirez, 2005: 14). This segment of the financial market plays an important role in financing high-risk innovation strategies fraught with uncertainties (Dosi, 1990). The providers of venture capital are characterised by their high willingness to take risks in conjunction with a detailed

10 knowledge of the innovation project. Hence, venture capitalists expect to participate in company management as well as in finance and there is a close relationship between investor and the innovating company. In other words, the strategies of the capital providers are in this case based on “voice-mechanisms” and less on “entry/exit-mechanisms” of pure selection. But of course this segment is linked to the “outsider-dominated“-segment of corporate financing in specific ways: For one thing, venture capital normally finances the particularly risky early phases of an innovation which the majority of investors shun. For another thing, venture capitalists ultimately aim at selling their interest in firms with successful radical innovations with high profit. A precondition for this are the market processes of an “outsider-dominated“ financial market (cf. Rajan/Zingales, 2001). c) Differentiations The central features of the two types of innovation systems are summarised in the following table 1:

Table 1: Types of Relations between Finance and Innovation Outsider-dominated Basic finance tool Investor orientation Investor expertise Basic agency conflict Relations between investor and innovator Investor strategy Venture capital market Dominant pattern of innovation Typical countries

Insider-dominated

Stocks and cash-flow Loans and cash-flow Short-termism Long-termism Finance-oriented Industry-specific Shareholder vs. management Insiders vs. management Loosely coupled; low industry- Tightly coupled; normally distinct specific expertise industry-specific expertise Dominance of selection Dominance of learning processes processes – “exit” – “voice” Key role for high tech innovation Limited influence High-tech/radical

Traditional/incremental

U.S.A.

Germany

This country-specific comparative perspective exaggerates particularities and oversimplifies the relations between financing and innovation, making further differentiation necessary: For one thing, national divergences within the type systems are neglected. Examples for this are, for instance, the differences within the Anglo-Saxon outsider-dominated system between the US and the UK with regard to the economic structure as well as, e.g., differences in the insider-dominated system

11 between Germany and France with respect to the role the state plays for corporate financing. For another thing, structural similarities between these type systems should not be overlooked. Thus Tylecote und Conesa (1999) point to insider elements in the outsider systems. As an example, they cite the significant role that family-owned companies play in the US, these companies are characterised by a tight coupling of financing and innovation strategies due to various forms of selffinancing of innovations. In addition, the VC-segment can also be referred to as “a bridge between two worlds“ (Rajan/Zingales, 2001: 477) as it has characteristics of both the “outsider-dominated“ and the “insider-dominated“ systems. Moreover, in most cases innovative activities are pursued in established firms. These firms normally access financial resources as whole entities and not with respect to individual projects. In different systems they may rely more on bank loans, bonds, or retained profits but the decision on innovation activities is then based on their global performance and not on the presumed profitability of an individual project (Dosi, 1990: 311). 4. Dynamics of the financial market Recent research emphasises the fact that the boundaries between the different country-specific innovation systems have begun to blur since the 1990s due to the internationalisation of the financial markets. It furthermore points out that the Anglo-Saxon forms of corporate financing are asserting themselves while the “insider-dominated“ forms of corporate financing and of corporate governance are eroding. According to the research findings, this is especially true for Germany, where the dissolution of the traditional networked system of the “Deutschland AG“ is very conspicuous. The researchers speak of a new production regime, which is referred to as “financial market capitalism“ (e.g. Kädtler/Sperling, 2002; Höpner, 2003; Dörre/Brinkmann, 2005; Windolf, 2005, 2008; Faust et al., 2006). The networked system of long-term lending by relatively autonomous universal banks tends to be replaced by an internationally oriented system based on Anglo-Saxon capital market and corporate financing norms, which leads to lasting changes in the system of corporate governance (e.g. Beyer, 2005; Höpner, 2003; Plumpe, 2005). In particular, the emergence of a market for corporate control is emphasised, on which businesses are bought or sold. It is generally assumed that this market has “disciplining effects“ on businesses because of changed power constellations and potentially possible as well as actually impending “hostile takeovers“ (Windolf, 2005: 49).Also the growing influence of financial actors like investment funds, their analysts and rating agencies has to be taken into consideration (Hirsch-Kreinsen, 1998; Windolf, 2005, 2008); and the researchers point to the in recent years worldwide greatly increased importance of not publicly regulated international forms of capital allocation within the scope of various kinds of private equity funds (The

12 Economist, 2006). This change is accompanied by changed financing modalities (so-called Basel IIRegulations) and the dissemination of and implementation of new and internationally standardised accounting procedures in the companies. There is also clear evidence of a lasting change in the notions and concepts about which profit objectives can be regarded as appropriate as well as in the corresponding management and corporate concepts with regard to relocation, outsourcing, networking and focusing of business functions. The question arises in which way these changes in the financing conditions of a hitherto “insiderdominated“ system such as Germany influence the innovation strategies of the enterprises? On the basis of available studies 4 as well as of empirical evidence, hypotheses will be formulated in the following, they characterise the changed patterns of coupling between financial market conditions and company innovation strategies. a) Constraints on the innovative capability of firms In research literature it is relatively explicitly argued that the change in financial market conditions is leading to constraints on the innovation capabilities and strategies of enterprises (Deutschmann, 2005, 2008; Lazonick, 2007): For neither is a sufficient stability of the financial means guaranteed nor is there sufficient strategic room for manoeuvre. Moreover, because of their lacking contextual knowledge, neither the dominant financial market players nor the new financing regulations and instruments are able to adequately assess the risks and uncertainties of technical innovations and their preconditions with regard to the corporate structure. Accordingly, collective learning processes and knowledge accumulation are seen to be curtailed and innovation projects to be reduced to calculable activities. In other words, the innovation dilemma is dissolved in favour of a dominant economic calculability and rationalisation of innovation processes. Consequently, technological innovations are solely conducted with short-term considerations and the criterion of risk avoidance. Empirically this situation is most likely to be encountered in the case of so-called listed firms with a pronounced financial market orientation. Massively increased, short-term oriented profitability criteria and expectations of investors can lead to an abandonment of innovation activities or at least to the curtailment of innovation perspectives and of the associated expenses. This is probably particularly true if the expected returns and the visibility of innovations are limited, for instance in traditional technological fields in which incremental innovations and a low rate of investment in R&D (“lowtech”) predominate. In this case one can assume that the autonomy of the management with respect 4

E.g.. Hirsch-Kreinsen, 1998; Lane, 2003; Schäfer et al., 2004; Deutschmann, 2005; 2008; Tylecote/Ramirez, 2005; Faust et al., 2006; Tylecote/Ramirez, 2006; Grewer, et al. 2007; Lazonick, 2007.

13 to the utilisation of financial resources, also of in-house financial resources, will be cut back. At any rate, however, the obligation of the management will increase to state reasons for such investments within the scope of the regular and short-term reports on the economic situation and on the earnings outlook. This restrictive situation for innovation projects is further aggravated by a general growing economic pressure on innovation activities, that also affects non-listed companies such as smaller and familyowned enterprises. This is due to the generally changed structures of the system of corporate financing and of granting of loans (Basel II-Regulations) with its risk-averse and intricate rating and evaluation procedures, which subject innovation projects to a more pronounced and systematic economic control than in the past (e.g. Belz/Warschat, 2005; Springler, 2007). According to available data, this applies in particular to enterprises from traditional sectors, which due to limited own resources to a large extent finance innovation activities with tied bank loans; thus in the years 20042006 around 30% of the companies from the food and furniture industries as well as from metal production and metalworking financed their innovation plans with loans (in addition to other sources of funding); around 21% of the mechanical engineering companies also availed themselves of bank loans (Rammer, 2009: 41). Furthermore, small and medium-sized enterprises in general are probably subject to these restrictions, as their financing is generally largely based on bank loans (Vieweg, 2001: 56). A second reason for the restrictive situation is the increasing application of international (USAmerican) standards of accounting which follow the principles of a stronger accountability towards external investors and are oriented towards the (listed) company value. These principles are increasingly being established in the methods of in-house controlling too, as a result the return expectations of investors are becoming a dominant target figure also of the corporate management (Botzem et al., 2007: 381). This can have twofold consequences: For one thing, managers often strictly avoid investments in uncertain and risky innovation projects so as not to unnecessarily weigh down the balance sheets. For another thing, the growing cost pressure, the introduction of rationalisation-based forms of work organisation and of shorter work cycles in the course of ongoing innovation processes often lead to the already mentioned “good enough-solutions“ and “pseudo solutions“ (Grewer et al., 2007: 78). A third reason for a the growing economic pressure on technological innovation processes are changed concepts of the relevant actors about appropriate profit objectives and changed management principles with regard to strategies, methods and organisation concepts. This applies

14 particularly to the organisation and management concepts often favoured by financial market players, management representatives and analysts, viz. concepts which focus on the so-called core business. As a consequence, the previous broadness and diversity of R&D areas and of engineering departments are reduced and centralised. Furthermore, the grown and (horizontally and vertically) integrated company structures and their adherent resources and knowledge base of many years are often only regarded as cost drivers and are dismantled. Hence company structures that were previously characterised by a high degree of integration of different functions, synergies, knowledge transfer and learning processes between various competence and knowledge areas as well as by organisational “slack“ and redundancies, are streamlined, thus abandoning important preconditions for the innovation capability of companies. b) Stabilisation of existing innovation patterns But in fact the question arises whether, as is presumed in the research literature, one can generally assume a tight coupling between the financial market and innovations and hence resulting constraints on the innovation strategies of enterprises. For the data of the years 2004 - 2006 shows that the enterprises in Germany use various financing sources for innovations: According to the data, many innovating enterprises make exclusive use of internal financial resources from ongoing business activities. Just as many enterprises combine internal with external financial sources; the exact figures are: 82% of all enterprises revert to internal financial sources, 41% of the enterprises make exclusive use of these while 41% of the enterprises combine them with external financial resources (Rammer, 2009: 41). In general, this means that enterprises are not often directly dependent on the increasingly restrictive financial market conditions for funding innovations but are at the most loosely coupled with them. This becomes even more apparent from the finding that research-intensive companies (“medium- and high-tech”) in particular revert to internal financing sources, this strategy is pursued by about 95% of these enterprises (ibid.). It can be assumed that the enterprises thus wish to secure room for manoeuvre for risky and far-reaching innovations. It can be also assumed that under otherwise equal conditions, so-called non-listed companies can secure room for manoeuvre vis-a-vis the changed financial market conditions because of their financing and ownership structures which are decoupled from the financial market. Fairly large family-run companies are often cited as examples for this. These companies have sufficient own capital resources and their productivity is generally considered to be very high (e.g. Kamp, 2007). Shareholder loans are a typical form of financing in this case. According to the above-mentioned data, approx. 18% of all innovating enterprises draw on these to finance their innovations. But listed

15 companies with a distinct financial market orientation can also try to maintain their autonomy and pursue innovation strategies independently, provided that their overall economic situation and their profitability are good. Finally, at the level of working processes, the structural conditions of research, development and design processes have to be taken into account. Their far-reaching and financial market-driven rationalisation would not only block essential innovation potentials, instead one also has to assume that they resist such rationalisation attempts. As has already been convincingly shown by work process studies (e.g. Eckardt, 1978; Wolf et al., 1992; Kalkowski et al., 1995), it is hardly possible to standardise and formalise innovation work due the ever present risks and uncertainties, i.e. the functional logic of these work processes in many cases counteracts such attempts. This is also true if the innovations processes were effectively reorganised as a result of new organisation and management concepts and the introduction of complex computer-aided systems. These systems have to be well adapted to the respective requirements, a task that only the experts on the operative level can accomplish, given the always occurring risks and uncertainties. A precondition for this is the “appropriation“ of the respective systems, i.e. the competent adaptation of these systems to the given conditions by their users. Hence structural barriers to the rationalisation of innovation processes and a substantial amount of power on the part of the involved scientists and development engineers are the result. This power inter alia also enables them to influence ratio indicators and benchmarking procedures according to their interests. c) New scope for innovation Under the changed financial market conditions one can even observe the emergence of new and extended scopes for innovation strategies. This applies to sectors or technology fields that are under considerable competitive pressure. Typical examples are the pharmaceutical and automotive industries, in which one can, in the context of a high financial market orientation, observe a lasting acceleration of innovations and an extensive increase in R&D expenditure in recent years (e.g. BMBF, 2007). In these cases, the investors attempt to achieve the desired increase in profitability precisely by investing more in R&D. Furthermore, the assumed changes in the system of corporate financing and corporate governance implicate a preference of relevant financial market actors for high-tech-based breakthrough innovations and corresponding company strategies. For in the case of success, they promise high yields and their results are also directly economically exploitable, e.g. by means of patents.

16 In addition, the changed financial market conditions by all means also entail an increasing availability of specific capital for innovation projects. Investors as well as industrially oriented private equity funds that pursue a long-term investment strategy and open up new room for increases in productivity and innovations are notable examples for this (Achleitner et al., 2008). The rising availability of venture capital for risky high-tech innovation projects is also of importance. The New Economy boom of the second half of the 1990s and the continuing rapid development

of

enterprises from the IT and biotechnology sectors are good examples for this connection (e.g. Champenois et al., 2006).Thus this type of innovation converges with the speculative and short-term profit taking motives of many investors who provide venture capital. A central condition for this is the recent easing of conditions for selling enterprises in Germany, it is now possible to sell highly innovative and successful high-tech companies at any time and thus gains can be rapidly realised. Of course, it is now also easier to buy up companies and to merge with other companies in order to enhance existing innovation potentials. It is indisputable that risk-oriented capital is opening up room for innovations in the high-tech sector. In the context of the closely networked financing system, such innovations used to be almost blocked in Germany. One indicator for this development is the fact that the national market alone for venture capital has featured a constantly growing volume in recent years (Vieweg, 2001; bkv-ev, 2006; BMBF, 2007). This trend is doubtlessly also reinforced by the pressure of enterprises that wish to capitalise on the innovation potentials of new technologies and are seeking funding possibilities for this purpose. In this connection, intensified state measures to encourage venture capital as well as new forms of promotion of innovation also play a significant role (e.g. KfW, 2004; Belz/Warschat, 2005). In addition, in the wake of the emergence of a market for venture capital, investment advice companies are being established which specialise on specific technology and innovation fields and are thus able to adequately assess the risks and uncertainties of technical innovations as well as the structures required for these and which offer the innovating companies corresponding advice services (e.g. Carpenter et al., 2003; Tylecote/Ramirez, 2006). Occasionally one can observe a close integration of personnel between innovating firms and smaller specialised capital providers, socalled business angels. All in all, one can ascertain that in the field of high-tech innovations a “sociotechnical field“ is establishing itself in Germany too (Bender, 2005). This field is characterised by a specific systemic connection between social structures and technological innovation courses and thus differs markedly from other innovation patterns and their corresponding social structures, for instance in the area of traditional technologies.

17

d) Development perspectives If one recapitulates the described developments and inquires into general development perspectives, then diverging structural changes of the insider-dominated innovation system can be discerned (see also table 2).

Table 2: Structural changes of the insider-dominated innovation system

Type of firms Available resources Sector/technological field Type of innovation Economic situation

Constraints Listed firms/SMEs

Stabilisation Non-listed firms/family owned, but also listed firms High internal

Limited internal, depending on external financing Traditional/established, Traditional/established, low-tech medium-tech/high-tech Incremental “Far reaching,” incremental Incalculable High innovative perspectives of pressure; economic innovation, difficult success economic situation

New scope Newly founded firms/start-ups Very limited, depending on external financing New, high-tech Radical High risks and uncertainty

The development perspectives are positioned within a broad spectrum of differing innovation foci: On the one hand, there are constraints on the companies‘ room for innovations, on the other hand new scope for innovations is opening up. Between both poles, older innovation foci are evidently holding their own. The German insider-dominated system is certainly not totally eroding and converging with the Anglo-Saxon outsider-dominated system. Following the new governance debate, one can rather speak of the emergence of a “hybrid“ innovation system (Lütz, 2006: 42). Although it is becoming more akin to the Anglo-Saxon model in many elements, in an international comparison it still features a specific configuration that is based on its seasoned foci and economic strengths. The institutional change can thus be conceived as “displacement“, i.e. “foreign“ system elements were integrated into an institutional system without giving up the hitherto existing and successful elements (Streeck/Thelen, 2005: 19). This development results in, on the one hand, an opening up of the insider-dominated system to new requirements that ensue from the international integration and the

18 rapid technological change. On the other hand, the hitherto existing specialisation advantages and the accompanying chances and competitive advantages on the world market persist. 5. Conclusion: Financial crisis and innovation If, in conclusion, one asks which consequences the worldwide financial crisis has for the innovation strategies of enterprises, one can at best put up some hypotheses for discussion. The conceptional and empirical problem in doing so is that in the present situation the structural crisis of the financial market and cyclical crisis tendencies are overlapping. On the question of the influence of economic cycles on innovations in enterprise there are some findings from innovation economics (cf. Geroski and Walters, 1995; Guellec and Ioannidis, 1999). These point to various cyclical factors that influence innovation decisions. Firstly, they emphasise the development of factor and goods prices as well as the capacity utilisation in enterprises, which all affect the internal financing possibilities. Secondly, expectations concerning the demand dynamics on the sales markets play an important role for innovation activities. Thirdly, the supply and demand circumstances on the financial market also change with the economic cycle. On the one hand, there are relatively advantageous possibilities of external debt financing of innovations in times of economic downturn, which normally feature low real interest rates. On the other hand, in times of economic downturn the prospects of alternative forms of financing such as venture capital deteriorate. Venture capital and similar forms of capital are usually more readily available in boom phases than in periods of recession due to capital inflows, positive expectations regarding the shareholder value and good exit opportunities. It is therefore generally emphasised in research literature that the correlations between economic cycles and innovations are ambiguous; pro-cyclical effects are seen alongside anti-cyclical effects (Rammer et al., 2004: 14). Furthermore, it is pointed out that these general correlations are in many cases modified by intervening factors. One of these is the change in sales market conditions, e.g. the appearance of new competitors, which compels enterprises to step up their innovation efforts irrespectively of all other conditions. Another factor is the company size, which entails differing internal and external financing possibilities and restrictions; thus SMEs are more likely to depend on external sources of finance than major enterprises. However, if major enterprises are listed, one can presume that the objective of maximising the company value leads to a rapid reduction of the innovation efforts. At the same time some findings indicate that companies that are managed by managers are more willing to take risks and are more innovation-oriented than other types of companies, for a thus achieved growth leads to higher management renumeration (cf. Czernitzki and Kraft, 2004). Finally, sectoral differences have to be taken into account. Thus even during an

19 economic slump there is probably a limit to the reduction of innovation activities in sectors with a high R&D-intensity, as innovations are a decisive competitive factor here. In less R&D-intensive sectors on the other hand, economic restrictions are much more likely to lead to a direct curtailment of innovation activities. These considerations can be linked to some considerations on the consequences of the financial crisis. In comparison to the above-outlined situation on the internationalised financial market, the structural conditions of corporate financing have not fundamentally changed, however some contradictory factors occur: •

Firstly, the relevant action arenas, in particular the internationalised market for corporate control are still largely intact; political protectionist measures are so far not discernible in this field.

•

Secondly, there are many indications that despite the massive destruction of assets, there is a high volume of available capital seeking investment opportunities in the long run. At the same time, however, it is obvious that in the short term the willingness to invest of investment funds and of private equity funds of various kinds has decreased. Reasons for this are a rising risk aversion and the dramatically reduced possibilities of credit financing of investments (in future probably also due to state-decreed restrictions on borrowing). It is not yet clear which consequences this situation will have on the market segment for venture capital.

•

Thirdly, the constellation of relevant financial market players is evidently only changing marginally. This applies especially to the investment funds and private equity funds of various kinds. It can be assumed that investment banks, analysts and rating agencies will continue to play an influential role on the financial market despite the observable international wave of bankruptcies and mergers and distinctive restructuring measures in the banking sector.

•

Fourthly, though, one can presume that financial regulations will be tightened, for lending regulations are already being tightened up and banks must hold a higher equity ratio. Fifthly, the pressure of high profitability expectations is not likely to diminish permanently; there are clear signs that the former norms are asserting themselves again.

However, there are presumably trends towards a loosening of the previously tight coupling between the financial market and the innovation strategies of listed companies in particular. The reasons stated for this are, for one thing, the reluctance of funds to invest and a loss of active influence on enterprises connected therewith. For another thing, it is emphasised that the pressure of shareholders for rapid and short-term profits has diminished. In this context, it is pointed out that

20 quarterly reporting is now under fire for having contributed to a push for higher returns. Furthermore it is reported that private equity funds are also increasingly focusing on long-term investments, thus trying to compensate for the loss of short-term high returns with long-term investments with lower, but stable yields (Paul, 2009). Moreover, as some top managers from international major enterprises have publicly commented on, many financial market players are beginning to realise that industrial people can manage and develop their businesses better than shareholders. Finally, in the case of many major enterprises a growing state influence plays a direct or indirect role, for it pushes back the previous influence of investors on companies (The Economist, 2009). Generally, the question which consequences a growing state influence can have on the innovation behaviour of firms has to remain unanswered. Given the dramatic national debt, it is furthermore not clear to which extent state innovation policy is in a position to pursue an anti-cyclical policy by systematically promoting innovations. From the point of view of innovating enterprises, the contradictory action situations outlined above probably intensify with the crisis in specific ways: On the one hand, it can be assumed that the hitherto existing room for innovations will diminish. The changed strategies of the enterprises themselves are the reason for this. These can be described with the terms reduction of capacities and costs as well as the securing and increase of internal liquidity. To achieve these goals, the R&D budget is probably markedly cut back in many cases. This trend is reinforced by the reduced possibilities of external financing; in this context the credit crunch, the risk-averse action of banks, the declining segment of the venture capital market and the probably reduced possibilities of informal financing of innovations by business angels or by means of bootstrapping must be mentioned. On the other hand, one should not overlook the innovation-conducive effect of the currently low real interest rates – provided that the enterprises can avail themselves of external funds. All in all, one can therefore assume that new room for targeted innovation strategies of enterprises is opening up and is taken advantage of precisely under the conditions of the current crisis. For enterprises can potentially gain a lasting competitive edge by means of accelerated innovations exactly under the current restrictive conditions.

21

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