Stock market, credit market, and heterogeneous innovations

The relative importance of credit market development and stock market development in boosting innovation remains a long‐standing debate issue. In this study, we document how different types of financial markets development affect heterogeneous innovations. Using a broad sample across 42 developed and emerging economies and a generalized difference‐in‐differences identification strategy, we find that stock market development leads to significantly higher substantive innovation, especially in young and small firms, but has negative impact on incremental innovation. Conversely, credit market development promotes incremental innovation, especially in mature and large firms, but has negative impact on substantive innovation. Further analyses indicate that stronger shareholder protection enhances the positive impact of stock market on substantive innovation, while stronger creditor rights enhance the promoting effect of credit market on incremental innovation, and even turn the negative impact of credit market on substantive innovation into positive. Our paper provides new insights into the heterogeneous effects of credit market and equity markets on the real economy.