Essays on Finance and Corporate Innovation
- Author(s): Fitzgerald, Tristan
- Advisor(s): Morse, Adair
- et al.
This dissertation studies the complex interrelationship between finance and corporate innovation policy. In the first two chapters, I consider the real impact that financial structures and corporate governance can have on firm technological innovation. First, I use property rights theory to highlight how alternative financial contracting structures differ in their ability to nurture the innovative activities of their investee firms. Second, I examine how the firm’s choice of Chief Executive Officer (CEO), specifically the firm’s choice to install a firm founder or a non-firm founder (“professional”) as CEO, can impact interrelated dimensions of corporate policy and ultimately firm value. In the final chapter, I study the stock market consequences of corporate technological innovation. Specifically, I evaluate the ability of equity analysts and public market investors to identify and value a firm’s innovation search strategy, characterized as a choice between the exploration of new technological capabilities and the exploitation of a firm’s existing technological competencies.
In Chapter 1, Financial Contracting for Innovation: Property Rights in Action, I study the relative ability of three financial contracting structures - namely independent venture capital (IVC), corporate venture capital (CVC) and strategic alliances - to promote entrepreneurial firm innovation. In property rights theory, financial contracting structures can align property rights to promote start-up firm innovation. I first provide novel estimates that strategic alliances have 6% to 11% higher overall innovative success rates compared to corporate venture capital and independent venture capital, respectively. Then, using a matched quasi-experiment in clinical trials to decompose selection (endogenous matching) and treatment effects, I find that strategic alliances promote 5% higher overall innovative success rates than both CVC and IVC (33% change in relative terms). I map the underpinnings of alliance success to the mechanisms of knowledge sharing and willingness to support costly experimentation.
In Chapter 2, ‘Til Death Do Us Part: The Relative Merits of Founder CEOs, I address a question faced by every firm in the economy, namely is it optimal for a firm’s founder to lead the company as CEO? To identify the treatment effect of founder CEOs on corporate policy and firm value, I exploit a natural experiment involving exogenous founder-to-professional CEO turnovers that arise from a founder’s death or illness. I find that, relative to comparable firms that retain their founder CEO, firms that must switch to a professional CEO experience a 10% reduction in their internally generated innovation. However, professional CEOs counteract this reduced internal R&D productivity by acquiring external technologies through greater M&A activity, increasing firm leverage and nurturing larger, more stable top management teams. These combined policy changes appear to have offsetting firm value implications, implying a “horses for courses” approach to choosing between a founder CEO and a professional CEO.
In Chapter 3, Innovation Search Strategy and Predictable Returns (with Benjamin Balsmeier, Lee Fleming and Gustavo Manso), we hypothesize that because of the intangible and highly uncertain nature of innovation, investors may have difficulty processing information associated with a firm’s innovation and innovation search strategy. Due to cognitive and strategic biases, investors are likely to pay more attention to unfamiliar explorative patents rather than incremental exploitative patents. We find that firms focusing on exploitation rather than exploration tend to generate superior subsequent short-term operating performance. Analysts do not seem to detect this, as firms currently focused on exploitation tend to outperform the market’s near-term earnings expectations. The stock market also seems unable to accurately incorporate information about a firm’s innovation search strategy. We find that firms with exploitation strategies are undervalued relative to firms with exploration strategies and that this return differential is incremental to standard risk and innovation-based pricing factors examined in the prior literature. This result suggests a more nuanced view on whether stock market pressure hampers innovation, and may have implications for optimal firm financing choices and corporate disclosure policy.