The Study of the Effect of Patent Application on SME
Financing (*)
Research Fellow: Kuniko MATSUMOTO
The situations of regional financial concentration and competition are different between small
and large cities in Japan. In this research, we analyze the effect of regional financial concentrationand competition on the growth and survival of small and medium-sized enterprises (SMEs) byusing Japanese official data, to indirectly clarify the regional financial concentration andcompetition in SME financing. The results show that regional financial concentration increases theexit rate of SMEs, and that the regional financial competition promotes the growth of SMEs andreduces the exit rate of SMEs.
Additionally, recently, policies to promote SMEs finance utilizing intellectual property havebeen established in Japan. We analyze how the regional financial concentration and competition
affect the effect of patent application on SME growth and survival by using Japanese official data
connected to patent data, to indirectly clarify the effect of patent application on the relationshipbetween regional finance situation and SME financing. The results show that the regional financial
concentration reduces the risk of exit by patent application, and the regional financial competition
increases the effect of promoting firm growth by patent application and decreases the risk of exit bypatent application.

I. Introduction
In Japan, small and medium-sized enterprises (SMEs) play a major role to support economic
activity and employment in Japan1. But many SMEs are have constrained finances. Especially,
newer SMEs face more financial constraint. In SME financing, financial institutions like banks play
an important role, because the financial dependence of SMEs on banks is higher than for large
firms.
Recently, financial institutions are becoming more important in regional policy in Japan,
because it is gradually becoming clear that innovation projects to promote regional development
have constrained finances. And financial institutions are expected to play a role of business
management support besides financial support. Since the late 2010s, regional policies attempt tomake industry-academia-government networks with financial institutions more strongly included.
The situations of regional financial concentration and competition are different between small(*) This is a summary of the report published under the 2017 Industrial Property Research Promotion Project entrusted by the Japan
Patent Office.
1 According to q Japan Small and Medium Enterprise Agency report, the number of SMEs accounts for about 99% of all firms andthe number of employees in SMEs accounts for about 70% of all employees in Japan.

iand large cities in Japan 2 . In the previous study, it is a concern that venture capital (VC)
concentration causes a regional equity gap because VCs prefer to invest in neighboring start-ups(Martin et al. 2005). Furthermore, the empirical evidence on whether bank competition promotes
finance constraint reduce and firm growth is inconclusive (de Guevara & Maudos 2009). If regional
financial concentration and competition affect SMEs’ financial constraints, it is a concern that a
regional gap of SMEs financing is caused. Furthermore, it is a concern that a gap in regional
development through SMEs activities is caused.
Additionally, in recent years, policies to promote SMEs finance utilizing intellectual property
have been established in Japan. Innovative firms face severe difficulties in external financing,
because innovation is a risky activity characterized by high levels of uncertainty and outputs ofinnovation are difficult to measure, evaluate and manage (Munari et al. 2011). But patents are
expected to help SME financing because they can act as a tangible signal of a firm's ability andreduce uncertainty by protecting their technologies (Levitas & McFadyen 2009; Kulatilaka & Lin2006). If patents help to reduce SMEs’ financial constraints, it is considered that patents affect therelationships between regional financial concentration and the growth and survival of SMEs.
In this context, the purposes of this study are the following two. One is to provide empiricalevidence of the effect of regional financial concentration and competition on SMEs’ growth andsurvival to indirectly clarify how the regional financial concentration and competition affects
SME financing. The other is to provide empirical evidence of the relationships between regional
financial concentration, competition and the effect of patents on SME growth and survival toindirectly clarify the effect of patent application on the relationship between regional financesituation and SME financing.
The paper is structured as follows. Section II describes the situations of regional financial
concentration and competition in Japan. Section III discusses the hypothesis and related theory.
The sources of the data and the adopted modeling analysis are discussed in section IV. Section V
describes the results of the analysis and considerations. Finally, Section VI concludes with asummary of the findings and directions for future work.

2

Refer to Section II.

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Ⅱ. Regional financial concentration and competition in Japan
In this section, in order to ascertain the trends of Japanese financial industry concentration andcompetition, we compare the trends of financial industry with the trends of other industries andcompare the regional financial industry trends by city size.
1. Trends compared with other industries
First, we use Lorenz curves and local Gini coefficients to clarify whether the financial industry
is more agglomerate than other industries. The Lorenz curve of financial employees is morestrongly curved than that of other industries. And the local Gini coefficient of financial employees
is higher than that of other industries’ employees. From these results, we find that more
agglomeration in the financial industry than in other industries.
Next, we use the entry and exit rates and the establishment period as indexes to clarify
whether the financial industry is more competitive than other industries. The entry and exit rates offinancial industry offices are lower than those of other industries. And financial industry offices are
established earlier than those of other industries. From these results, we ascertain that financial
industry offices are replaced less frequently than in other industries and survive longer; in otherwords, the competitive environment of financial institutions is more stable than that of otherindustries.
2. Trends by city size
First, we use the number of employees by financial office and the specialization coefficient offinancial employees as indexes to clarify whether the larger a city's financial industry, the more
agglomeration. The larger the city, the more employees in financial offices and the higher the
specialization coefficient of the financial employees. This means the larger the city, the larger andmore agglomerated the financial offices.
Next, we use four indexes to clarify whether the larger a city's financial industry, the morecompetitive. The first indexes are the entry and exit rates, the second is the establishment period,
the third is the share of banks that are profit-making corporations, and the last is the HerfindahlHirschman index (HHI) which is famous as a statistical measure of concentration. The larger city,
the higher the entry and exit rates of financial offices and the shorter the establishment period
thereof. And the larger city, the higher the share of banks and the lower the HHI of the financial
office. That is, the larger the city, the more competitive the environment of financial institutions.

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Ⅲ. Theory and Hypothesis
In this part, we develop testable hypotheses about the relationships between regional financial
concentration and the growth and survival of SMEs and the effect of patents on SME growth andsurvival by discussing two viewpoints: geographical proximity and relationship banking. For thecase of regional financial competition, we discuss two viewpoints: the principle of competition andrelationship banking.
1. The relationships between regional financial concentration and the growth and survival of
SMEs
First, geographical proximity helps to decrease the information asymmetry and promote
gaining of credit by making direct contact easier (Lutz et al. 2013). Therefore, if there are manyfinancial offices nearby, SMEs are more likely to make contacts with financial institutions, whichmakes it easier to raise funds.
Hypothesis 1-1A: SMEs in the region where financial offices are more concentrated grow rapidly.
Hypothesis 1-2A: SMEs in the region where financial offices are more concentrated survive more.
Second, the financial concentration decreases relational switching costs of SMEs because it
makes it easier to search for a partner. Then, financial offices have less incentive to conduct
relationship banking due to the risk of failure in recovering information costs. Therefore, if there
are many financial offices nearby, it makes it difficult for SMEs to finance by relationship banking.
Hypothesis 1-1B: SMEs in the region where financial offices are less concentrated grow rapidly.
Hypothesis 1-2B: SMEs in the region where financial offices are less concentrated survive more.
2. The relationships between regional financial concentration and the effect of patents on
SMEs growth and survival
Patents can act as a useful signal of decreasing information asymmetry by showing firms'
innovation and technological capacity to external investors (Levitas & McFadyen 2009).
Furthermore, patents are tools which firms can use to protect their technologies and acquire feesfrom the licensing of technologies to third parties (Kulatilaka & Lin 2006). Hence, patents help toreduce financing constraints, and as a result, firms’ growth and survival are promoted. When it isdifficult to make the mechanisms which help SME growth and survival work, we expected thiseffect of patents on SMEs growth and survival to increase.

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Namely, the effect of patents is increased in regions where financial offices are lessconcentrated because SMEs are less likely to make contacts with financial institutions.
Hypothesis 2-1A: SMEs which are patent applicants in a region where financial offices are lessconcentrated grow rapidly.
Hypothesis 2-2A: SMEs which are patent applicants in a region where financial offices are lessconcentrated survive more.
Whereas, the effect of patents is increased in regions where financial offices are moreconcentrated because it makes it difficult for SMEs to finance by relationship banking.
Hypothesis 2-1B: SMEs which are patent applicants in a region where financial offices are moreconcentrated grow rapidly.
Hypothesis 2-2B: SMEs which are patent applicants in a region where financial offices are moreconcentrated survive more.
3. The relationships between regional financial competition and the growth and survival of
SMEs
First, the financing cost of SMEs is lower in regions where financial offices keenly compete
because the principle of competition works strongly, and SMEs actively deal with financial
institutions (Angelini et al. 1998; Berlin & Mester 1999). In addition, the hold-up problem (Rajan
1992) is less likely to come up because SMEs can avoid being locked-in to a particular financial
institution.
Hypothesis 3-1A: SMEs in the region where financial offices keenly compete grow rapidly.
Hypothesis 3-2A: SMEs in the region where financial offices keenly compete survive more.
From another point of view, it makes it difficult for SMEs to finance by relationship banking
because relational switching costs of SMEs are lower in regions where financial offices keenlycompete.
Hypothesis 3-1B: SMEs in the region where financial offices dully compete grow rapidly.
Hypothesis 3-2B: SMEs in the region where financial offices dully compete survive more.

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4. The relationships between regional financial competition and the effect of patents on SMEs
growth and survival
As in the case of concentration, when it is difficult to make the mechanisms which help SME
growth and survival as described in the previous section work, we expected this effect of patents on
SMEs growth and survival to increase.
Namely, the effect of patents is increased in regions where financial offices dully compete
because the principle of competition works weakly.
Hypothesis 4-1A: SMEs which are patent applicants in the region where financial offices dully
compete grow rapidly.
Hypothesis 4-2A: SMEs which are patent applicants in the region where financial offices dully
compete survive more.
Whereas, the effect of patents is increased in regions where financial offices keenly compete
because it makes it difficult for SMEs to finance by relationship banking.
Hypothesis 4-1B: SMEs which are patent applicants in regions where financial offices keenlycompete grow rapidly.
Hypothesis 4-2B: SMEs which are patent applicants in regions where financial offices keenlycompete survive more.

Ⅳ. Methods
We adopt the following two models for analyzing the effect of regional financial concentrationand competition on SMEs' growth and survival, which are based on the analysis model adopted inprevious studies3.
(1) Growth-rate Analysis Model
Growth𝛼 Bank Dependence ∗ Bank Concentration
𝛽 Bank Dependence ∗ Bank Competition𝛿 Firm Year

𝛿 Firm Size𝛿 Area Size𝛿 Area Effect3

𝛾 Patent𝛿 Industry Growth𝛿 Industry Effect𝜀As representative studies, Rajan & Zingales (1998), CETORELLI & STRAHAN (2006) and de Guevara & Maudos (2009) arecited.

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(2) Exit-rate Analysis Model
Dead Rate𝛼 Bank Dependence ∗ Bank Concentration
𝛽 Bank Dependence ∗ Bank Competition𝛿 Firm Year

𝛿 Firm Size𝛾 Patent

𝛿 Area Size𝛿 Area Effect𝛿 Industry Growth𝛿 Industry Effect𝜀where i is the firm; j is the industry middle sector; j’ is the industry large sector; k is the city inwhich the firm is located; and k’ is the prefecture in which the firm is located. Regarding thedependent variables, Growth is the firm’s employees growth rate and Dead Rate is the firm’s
exit dummy variable. Regarding the independent variables,

Bank Concentration 4 is theindicator of the degree of bank agglomeration in city k, which is proxied by the specialization
coefficient of the financial employees; Bank Competition 4 is the indicator of the degree of bankconcentration in city k, which is proxied by the Herfindahl-Hirschman index (HHI) of bank offices;and Patent is the indicator of the firm’s activity in patent application, which is proxied by theamount of the firm’s patent applications or a patent application dummy variable. Regarding thecontrol variables, Firm Year is the period from the firm’s establishment year until 2009;
Firm Size is the number of the firm’s employees; Area Size is the number of offices in city k;andIndustry Growthis the industry’s employee growth rate. Finally,

Area EffectandIndustry Effect , which are proxied by prefecture and sector dummy variables, capture theinfluence of effects specific to each prefecture or sector, respectively.
Firstly, we adopt OLS analysis in the growth-rate analysis model and probit analysis in the
exit-rate analysis model in order to clarify the effect of regional financial concentration andcompetition on SME growth and survival. Secondly, we divide cities into two groups depending on
the degree of regional financial concentration or competition and compare the effect of patents on
SME growth and survival of two groups in order to clarify the relationships between regional
financial concentration and the effect of patents on SME growth and survival.
In this analysis, we use the data that we constructed based on patent data and office census
data. The patent data consists of applicants and patent information in Japan between 1989 and 2008.
The office census data consists of data on SMEs which have a single office in 2009 and 2012.

4

We adopt [Bank Dependence], which is the indicator of the degree of bank financial dependence of SMEs or all firms in sector j,
in order to consider the effect of external financial dependence.

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Ⅴ. Results and Consideration
1. The relationships between regional financial concentration and the growth and survival of
SMEs
Regarding the relationships between regional financial concentration and the growth of SMEs,
we find no significant effect. Whereas, we confirm that the coefficient of the relationships between
regional financial concentration and the exit-rate of SMEs has a significantly positive. From theseresults, hypothesis 1-2B is supported. That is, these results suggest that regional financial
concentration does not affect SMEs' growth but increases the risk of exit for SMEs. We areconcerned that SMEs suffer relationship banking constraints in regions where financial offices are
more concentrated.
2. The relationships between regional financial concentration and the effect of patents on
SMEs growth and survival
First, regarding the effect of patents on SME growth and survival, the results show that patents
have a positive effect in promoting SME growth and a negative effect in promoting SMEs survival.
Next, regarding the relationships between regional financial concentration and these patenteffects, we confirm that regional financial concentration does not affect the patent positive effect on
SME growth but reduces the patent negative effect on SME survival. From these results, hypothesis
2-2B is supported. We suggest that patents help to reduce financing constraints more effectively inregions where financial offices are more concentrated.
3. The relationships between regional financial competition and the growth and survival of
SMEs
Regarding the relationships between regional financial competition and the growth of SMEs,
we find a significant negative effect. Regarding the relationship to SME survival, we confirm asignificant positive effect. From these results, hypothesis 3-1B and hypothesis 3-2B are supported.
That is, these results suggest that regional financial competition slows down SMEs' growth andincreases the risk of exit for SMEs. We are concerned that SMEs suffer relationship banking
constraints in regions where financial offices keenly compete.

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4. The relationships between regional financial competition and the effect of patents on SMEs
growth and survival
Regarding the relationships between regional financial competition and these patent effects,
we confirm that regional financial competition decreases the patent positive effect on SME growthand increases the patent negative effect on SME survival. From these results, hypothesis 4-1A andhypothesis 4-2A are supported. We consider that patents help to reduce financing constraints more
effectively by promoting relationship banking or alleviating the hold-up problem in regions where
financial offices dully compete.

Ⅵ. Conclusion
In SME financing, financial institutions like banks play an important role, because thefinancial dependence of SMEs on banks is higher than for large firms. In recent years, policies topromote SMEs finance utilizing intellectual property have been established in Japan. Further,recently, financial institutions are becoming more important in regional policy in Japan because it isgradually becoming clear that innovation projects to promote regional development haveconstrained finance. Comparing the regional financial industry trends by city size, we find thelarger the city, the larger and more agglomerated the financial offices and the more competitive theenvironment of financial institutions.
In this context, we analyze the effect of regional financial concentration and competition on
SME growth and survival to indirectly clarify how regional financial concentration and competition
affect SME financing. Furthermore, we analyze the relationships between regional financial
concentration, competition and the effect of patents on SME growth and survival to indirectly
clarify the effect of patent application on the relationship between the regional finance situation and
SME financing.
As the results, firstly, regarding the effect of regional financial concentration and competition
on SME growth and survival, we suggest that regional financial concentration increases the risk ofexit for SMEs and regional financial competition slows down SMEs' growth and increases the riskof exit for SMEs. We consider relationship banking rather than financing cost reduction as
important for SMEs' growth and survival. Considering the regional financial environment in Japan,
SMEs in smaller cities grow rapidly and reduce the risk of exit by utilizing relationship banking
more easily. This may suggest that the Japanese policy which promotes regional relationshipbanking is effective.
Secondly, regarding the relationships between regional financial concentration, competition andixthe effect of patents on SMEs growth and survival, we confirm that regional financial concentration
reduces the patent negative effect on SME survival and regional financial competition decreases thepatent positive effect on SME growth and increases the patent negative effect on SME survival.
These results suggest that patents help to reduce financing constraints more effectively in regions
where financial offices are more concentrated and reduce financing constraints more effectively bypromoting relationship banking or alleviating the hold-up problem in regions where financial offices
dully compete. So, future research should elucidate how these findings are caused to make policies topromote SME finance utilizing intellectual property more efficiently.
Finally, we describe some directions for future research. One is the improvement of analysis,for example, using financing data for direct analysis, adopting more suitable analysis methods likepanel analysis. The other is adding further analysis points of view, for example, entry-rate.

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