Interest rate liberalization and corporate innovation: Evidence from natural experiments in China

Abstract We examine whether and how interest rate liberalization affects corporate innovation in China. Using the removal of the interest rate ceiling and floor as exogenous shocks, and the numbers of granted patents to proxy for corporate innovation, we find that corporate innovation increases after interest rate liberalization. Our finding holds through several robustness tests. Furthermore, we show that state‐owned enterprises (SOEs) and non‐SOEs benefit from interest rate liberalization differently: Non‐SOEs benefit more from interest rate ceiling removal, whereas SOEs benefit more from interest rate floor removal. Cross‐sectional analyses also show that the effect is more pronounced when bank competition is higher and when firms rely more on external finance. Exploring potential channels through which interest rate liberalization spurs innovation, we find that although ceiling removal mitigates firms’ financial constraints, floor removal lowers corporate loan costs. Our study provides evidence of how financial reform benefits the real economy.