Corporate Innovation, Default Risk, and Bond Pricing

Abstract

Prior literature documents mixed evidence about how research and development activities affect corporate creditworthiness. We investigate whether publicly available patent information is incrementally useful in assessing the benefits and risks of corporate innovation from bondholders’ perspective. We find that firm-level innovation performance — measured in terms of the level, impact, generality, and originality of firms’ patents — is a determinant of bond issuers’ perceived default risk and, by extension, corporate bond pricing. Investors consider more technologically innovative bond issuers to have lower default probabilities; consequently, bonds issued by more innovative firms have lower issuance premiums and lower realized excess returns. Our findings are further supported by instrumental regressions that use the monetary and time costs of innovation, and by cross-sectional tests based on exogenous shocks from state-level R&D tax credits.

Keywords: Innovation, patent, default risk, bond premium, bond return

JEL Classification: G12, O32