How do shareholders motivate managers to pursue innovations that result in patents when substantial potential costs exist to managers who do so? This question has taken on special importance as promoting these kinds of innovations has become a critical element of not only the competition between companies, but also the competition between nations. In our paper, Motivating Innovation in Newly Public Firms, forthcoming in the Journal of Financial Economics, we address this question by providing empirical tests of predictions arising from recent theoretical studies of this issue.
Posts Tagged ‘Innovation’
It is often argued that venture capital (VC) plays an important role in promoting innovation and growth. Consistent with this belief, governments around the world have pursued a number of policies aimed at fostering local venture capital activity. The goal of these policies has been to replicate the success of regions like Silicon Valley in the United States. However, there remains scarce evidence that the activities of venture capitalists actually play a causal role in stimulating the creation of innovative and successful companies. Indeed, venture capitalists may simply select companies that are poised to innovate and succeed, even absent their involvement. In this case, efforts by policy-makers to foster local venture capital activity would be misguided. In our paper, The Impact of Venture Capital Monitoring: Evidence from a Natural Experiment, which was recently made publicly available on SSRN, we examine whether the activities of venture capitalists do indeed affect portfolio company outcomes.
Do firm boundaries affect the allocation of resources? This question had spawned significant research in economics since it was raised in Coase (1937). A large body of work has focused on comparing the resource allocation in conglomerates relative to stand-alone firms to shed light on this issue. Theoretically, there are competing views on this aspect. On the one hand, Alchian (1969), Wiliamson (1985), and Stein (1997), among others, have put forth the view that conglomerates, by virtue of exerting centralized control over the capital allocation process, may do a better job in directing investments than the external capital markets. On the other hand, the “dark side” view of internal capital markets argues that problems of corporate socialism are more prevalent in conglomerates making them less efficient in resource allocation (Rajan, Servaes, and Zingales, 2000; Scharfstein and Stein, 2000).
Research on the composition and structure of the board of directors is a thriving subject in the aftermath of the financial crisis. The discussion thus far has assumed that finding the right board members is extremely important because they tend to enhance corporate strategy and decision-making. Consider the case of Apple’s board. Following Steve Jobs’ return to the firm in 1997, he understood well the important role of the board of directors to both improve company productivity and build relationships with its suppliers and customers. In order for the board of directors to become a competitive advantage and help carry Apple forward, its members needed to have a thorough understanding of the computer industry and the firm’s products. Accordingly, a change in the composition of the board of directors was arguably a necessary first step to bring back focus, relevance and interaction (with the outside world) to the company in its journey to introduce disruptive innovations and creative products to its customers. The result was impressive: Between August 6th, 1997 (the day the “new” board was introduced) and August 23rd, 2011 (the last day of Jobs as the CEO of Apple), the stock price soared from $25.25 to $360.30, increasing 1,327 per cent.
It has long been argued that synergies are key drivers of mergers and acquisitions (M&As), and that many M&As occur due to technology reasons. However, there is little direct evidence of whether and how synergies in the technology space drive individual firms’ decisions to participate in M&As, and of how they affect merger outcomes. In our paper, Corporate Innovations and Mergers and Acquisitions, forthcoming in the Journal of Finance, we first examine the relation between characteristics of corporate innovation activities and whether a firm becomes an acquirer or a target firm. We then study whether technological overlap between firm pairs affects transaction incidence. Finally, using a sample of bids withdrawn due to reasons exogenous to innovation as a control sample, we estimate the effect of a merger on future innovation output when there is pre-merger technological overlap between merging firms. Our large and unique patent-merger data set over the period 1984 to 2006 allows us to construct targeted measures of innovation output and technological overlap, extending the analysis of Hoberg and Phillips (2010) in product markets.
While much has been published on the business case for sustainability during the last decade, businesses have been slow to adopt the green innovation and sustainability agenda. Reasons include a lack of consistency in the indicators employed by analysts, and a failure to effectively incorporate financial value drivers into the equation. This article defines a green business case model that includes seven core financial value drivers of special interest to financial analysts.
Researchers, management experts, and activists have published extensively over the last decade on the business case for sustainability. The accumulated evidence and experience makes it clear that sustainability actions do not have a negative or neutral impact on the financial performance of a business. Rather, it is a question of the degree to which sustainability actions have a positive impact on financial performance. One research overview has identified more than 60 benefits, clustered into seven overall business benefit areas.
As greater attention is paid today to integrated thinking and more sustainable business models, the link between sustainability actions and corporate financial performance remains central. However, the business case evidence collected to date has failed to have the expected scale of impact. One reason for this is the lack of consistency in indicators employed by analysts in their examination of possible cause and effect relations. Another is the gap in discipline between sustainability experts and financial officers, with each community conversing in its own language (jargon). Sustainability activists have failed to get a better grasp on corporate finance, while financial officers have failed to get a better grasp on the sustainability agenda.
In our paper, The Dark Side of Analyst Coverage: The Case of Innovation, forthcoming in the Journal of Financial Economics, we examine the effect of analyst coverage on firm innovation and test two competing hypotheses. We find that firms covered by a larger number of analysts generate fewer patents and patents with lower impact. To establish causality, we use a difference-in-differences approach and an instrumental variable approach. Our identification tests suggest a causal effect of analyst coverage on firm innovation. The evidence is consistent with the hypothesis that analysts exert too much pressure on managers to meet short-term goals, impeding firms’ investment in long-term innovative projects. Finally, we discuss possible underlying mechanisms through which analysts impede innovation and show a residual effect of analyst coverage on firm innovation even after controlling for such mechanisms. Overall, our study offers novel evidence of a previously under-explored adverse consequence of analyst coverage, namely, its hindrance to firm innovation.
In our paper, Innovation, Reallocation, and Growth, which was recently made publicly available on SSRN, we build a micro-founded model of firm innovation and growth, enabling us an examination of the forces jointly driving innovation, productivity growth and reallocation. In the second part of our paper, we estimate the parameters of the model using simulated method of moments on detailed U.S. Census Bureau micro data on employment, output, R&D, and patenting during the 1987-1997 period.
Our model builds on the endogenous technological change literature. Incumbents and entrants invest in R&D in order to improve over (one of) a continuum of products. Successful innovation adds to the number of product lines in which the firm has the best-practice technology (and “creatively” destroys the lead of another firm in this product line). Incumbents also increase their productivity for non-R&D related reasons (i.e., without investing in R&D). Because operating a product line entails a fixed cost, firms may also decide to exit some of the product lines in which they have the best-practice technology if this technology has sufficiently low productivity relative to the equilibrium wage. Finally, firms have heterogeneous (high and low) types affecting their innovative capacity—their productivity in innovation. This heterogeneity introduces a selection effect as the composition of firms is endogenous, which will be both important in our estimation and central for understanding the implications of different policies. We assume that firm type changes over time and that low-type is an absorbing state (i.e., high-type firms can transition to low-type but not vice versa), which is important for accommodating the possibility of firms that have grown large over time but are no longer innovative.
In the paper, Takeover Defenses as Drivers of Innovation and Value-Creation, forthcoming in the Strategic Management Journal, I analyze the role of anti-takeover provisions in ameliorating agency conflicts of managerial risk aversion in certain types of companies.
The desirability of anti-takeover provisions (ATPs) is a contentious issue. ATPs can lead to shareholder wealth-destruction by insulating managers from disciplinary takeovers and enabling them to engage in empire building. However, without ATPs, managers of hard-to-value (HTV) firms, which might trade at a discount due to valuation-difficulties, are exposed to ‘opportunistic takeovers’ (which aim to take advantage of low stock prices), potentially causing managerial myopia and under-investment in innovative projects. Thus, in HTV firms, ATPs might serve as credible commitments to encourage managers to make value-creating investments, but in easier-to-value firms, they might lead to inefficient governance.
A recent book by Josh Lerner and a recent article in the Journal of Public Economics has asserted that government venture capital programs in Europe have displaced or crowded out private venture capital. The result of work such as this has been to place pressure on government bodies around the world to remove or replace their existing governmental programs. In the aftermath of the financial crisis, venture capital markets around the world themselves have been in crisis. So, it is particularly timely to address the issue of whether or not government venture capital programs in regions such as Europe really have in fact crowded out private venture capital programs.
As pointed out in this Economist article and in my recent commentary and my review article, the idea that government programs crowding out private venture capital in Josh Lerner’s book and in the Journal of Public Economics is based on empirical measures that are completely flawed. The empirical tests supporting crowding out are based on methodologies that rank the Austrian and Hungarian venture capital markets as being the best in the Europe, and the U.K. venture capital market as being the worst in Europe (I am not kidding).