Do innovation and financial constraints affect the profit efficiency of European enterprises?

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.