Corporate diversification and innovation: Managerial myopia or inefficient internal capital markets?

Which is more innovative: the decentralized, diversified firm, or the centralized, more narrowly focused firm? The economics and finance literatures argue that diversified firms have innovation advantages as their operating units have access to an internal capital market. In contrast, the strategy and entrepreneurship literatures argue that managers of these firms suffer from “managerial myopia,” discouraging them from investing in projects with long-term, uncertain payoffs. We take a fresh look at the relationship between innovation and diversification using a comprehensive sample of diversified and nondiversified firms and a novel approach that teases out the mechanisms influencing the relationship between diversification and innovation. Consistent with conceptual and empirical work in strategy, we find a robust negative correlation between diversification and R&D intensity, suggesting that diversification reduces innovation by discouraging investment. However, our analysis suggests that internal capital market inefficiencies, rather than managerial myopia, is responsible for this observed negative relationship.     

Intellectual Capital Profiles: An Examination of Investments and Returns*

ABSTRACT Using data collected from executives in 208 organizations, this study takes a configurational approach to examine how human, social, and organizational capital coexist to form distinct intellectual capital profiles across organizations. We then examine how investments in human resource management (HRM), information technology (IT), and research and development (R&D) differ across these intellectual capital profiles and investigate differences in financial returns and Tobin's q between the profiles. Results indicate that a relatively small group of superior performing organizations exhibit high levels of human, social, and organizational capital. Most firms, however, tend to focus primarily on only one form of intellectual capital, and a small group of underperforming organizations have very low levels of all three types of intellectual capital. At a general level, HRM and IT investments appear to influence intellectual capital development more than R&D investments. More specifically, HRM investments tend to be higher in firms with profiles high in human and social capital, while IT investments are stronger in firms with profiles high in social capital. Further, HRM, IT, and R&D investments are all very high in the group of superior performing organizations that have high levels of human, social, and organizational capital.     

Endogenous Technological Spillovers: Causes and Consequences

We develop a new approach to endogenizing technological spillovers. We analyze a game in which firms can first invest in cost-reducing R&D, then compete on the human-capital market for their knowledge-bearing employees, and finally enter the product market. If R&D employees change firms, spillovers arise. We show that technological spillovers are most likely when they increase total industry profits. We use this result to show that innovation incentives are usually stronger for endogenous than for exogenous spillovers and that endogenous spillovers may reverse the result that innovation incentives are stronger under quantity competition than under price competition. Finally, we explore the robustness of our results with respect to contractual incompleteness and the number of R&D workers.     

Residual income claimancy,monitoring, and the R&D firm: Theory with application to biotechs

This paper models the assignment of residual income claimancy to an R&D manager and applies the model to biotechnology firms. Residual income claimancy provides incentives for the manager to monitor the R&D process. Since the nature of R&D and of monitoring scientific effort is different, our model predicts stark differences in the residual income claimancy of managers and in other aspects of organization for innovative R&D firms like biotechs. In particular, R&D firms are expected to be more owner‐managed, more expert‐managed, and smaller in size. Cross‐sectional data on biotechnology firms is consistent with these implications. Additionally, longitudinal data indicate that as firms alter their focus on biotech research, their organizational structure changes as expected. Our approach suggests a process of firm and industry evolution related to technological maturity and points to the importance of incentives rather than risk sharing in determining organizational form, similar to the original analysis of franchising. Copyright © 2004 John Wiley & Sons, Ltd.     

The R&D Investment–Uncertainty Relationship: Do Strategic Rivalry and Firm Size Matter?

This paper uses a real options perspective to augment a standard research and development (R&D) investment model and implement a firm‐level empirical analysis to assess the practical significance of market uncertainty and its interactions with strategic rivalry and firm size. We use a measure of firm‐relevant market uncertainty along with panel data and find that firms invest less in current R&D as uncertainty about market returns increases. The effect of firm‐specific uncertainty on R&D investment is smaller in markets where strategic rivalry is likely to be more intense. Furthermore, holding access to financing constant, the effect of uncertainty on R&D investment is attenuated for large firms. Copyright © 2012 John Wiley & Sons, Ltd.     

Home market effects with endogenous costs of production

In a standard imperfect competition model, we endogenize the costs of production of firms in the increasing returns sector (IRS) via process R&D. We show that firms in the larger region in terms of demand invest more in R&D (i.e.: they are bigger in size and have lower marginal costs) than firms in the smaller region, since the former exploit larger economies of scale in production to pay for the costs of R&D. As a result, when the return on R&D is high, the larger region does not employ disproportionately more labor nor attracts a disproportionately larger share of firms in the IRS in relation to share of demand it hosts, i.e.: negative home market effects (HMEs) in employment and in the number of firms. When this occurs, only partial agglomeration of the IRS in the larger region is sustainable in equilibrium. Even so, the larger region always runs trade surplus in the IRS, i.e.: HME in trade patterns.     

Relative CEO Underpayment and CEO Behaviour Towards R&D Spending

abstract Arguments based on labour market theory suggest that there may be CEO behavioural issues related to pay deviations from the labour market rate for CEO pay; however, few studies examine this phenomenon. This study attempts to address such behavioural issues by examining the influence of relative CEO underpayment on reductions in R&D spending, the differences in this relationship between firms in high R&D intensive versus low R&D intensive industries, and the moderating affect of ownership structure on the CEO underpayment and R&D spending relationship. Results suggest that relative CEO underpayment is associated with reductions in R&D spending in low R&D intensive industries and increases in R&D spending in high R&D intensive industries. Also, greater relative CEO underpayment leads to greater reductions in R&D spending in manager‐controlled organizations as compared to owner‐controlled organizations. This study provides evidence that pay deviations may, in fact, affect certain CEO behaviours, specifically relating to innovation.     

Capitalizing Research & Development: Signaling or Earnings Management?

This paper analyzes the capitalization of Research & Development (R&D) expenditures under International Financial Reporting Standards (IFRS). Discretionary R&D capitalization can be exercised by managers to signal private information on future economic benefits to the market. It can, however, also serve as opportunistic earnings management. We analyze a unique, hand-collected sample of highly R&D intensive German IFRS firms during 1998–2012. We find that market values are not associated with capitalized R&D for the overall sample, indicating that earnings management may be a concern. We identify firm-years for which R&D capitalization is possibly used for pushing their earnings above a specific threshold (e.g. analysts' forecasted earnings, prior year's earnings). Our results show that both the decision to capitalize and how much to capitalize are strongly associated with benchmark beating. Consistently, we find that market values are negatively associated with capitalized R&D for firms who are likely to use capitalization for benchmark beating (about one third of the overall sample). On the other hand, the market values R&D capitalization positively for well-performing firms, for which capitalizing does not matter to beat an earnings benchmark (about half of the overall sample). This finding is robust to controls for endogeneity, various deflators, and different measures for earnings management.     

Governance and effects of public R&D subsidies: Evidence from China

This study examines the effects of public research and development (R&D) subsidies and the governance of such subsidies on firm productivity based on the analysis of a firm-level panel dataset between 1998 and 2007 in China. It is found that public R&D subsidies tend to support more productive firms and the productivity of these government-backed firms is improved further after they get the government support. Less attention is paid to the observable or measurable performance measurements in ex-ante project selection, and the ex-post effects are stronger when the governance of the public R&D subsidies becomes more decentralized due to an exogenous policy change. In other words, better decentralization of governance is associated with more pronounced effects of R&D subsidies. Identification concerns are addressed with various approaches to confirm the treatment effect of public R&D subsidies and the governance of such subsidies.     

Are venture capitalist-backed IPOs more innovative? Evidence from an emerging market

This study examines whether venture capital (VC)-backed IPOs are more innovative than otherwise equivalent non-VC-backed IPOs. Using manually collected R&D records from annual reports and patent data from the Chinese State Intellectual Property Office (CSIPO) from 2007 to 2012, we find that VC-backed IPOs have higher R&D expenditures and more patents granted in the three years after IPOs. More specifically, they have more invention, application, and design patents in post-IPO. We use a two-stage instrumental variable, propensity score matching, difference-in-differences approach to mitigate selection biases and find our results to be consistent with our hypothesis. We conclude that VCs can positively influence IPO firms to increase R&D expenditures and innovative output levels in China. In addition, we document that the government ownership adversely affects innovation of VC-backed firms. Policy implications are discussed.     

Short-term R&D bias,competition on cost rather than innovation,and time to market

Mounting evidence indicates that capital markets often apply short-term pressure on firms to gain short-term results by focusing primarily on reported financial performance. As a result of short termism, it has been argued that companies are likely to cut expenditure on R&D which might otherwise improve longer-term performance. As there is a growing consensus that R&D is critically important to both organizational and national performance, short termism may have significant detrimental organizational consequences. One implication arising from a short-term R&D bias, and examined in this paper, is its effect on market time reduction. Arguments are examined that suggest a dominant R&D strategy is to reduce product time to market. Concerns have been expressed, however, that such a strategy is applicable in specific circumstances only. A review of the literature suggests that analyst and shareholder bias against high-risk, long-term research in favor of lower-risk, short-term product R&D influences organizations to reduce the time it takes to get a product to market when the emphasis in the marketplace is on cost competition rather than product innovation. The findings of the study suggest that when the emphasis on competition on cost rather than innovation is low, short-term R&D bias does not affect market time. In contrast, when the emphasis on competition on cost rather than innovation is high, the results indicate that short-term R&D bias positively influences market time reduction. The study concludes with suggestions for further research.     

MNEs,technological efforts and channels of export spillover: An analysis of Indian manufacturing industries

The present study provides some empirical evidence for the export spillover effect examining the case of an emerging market economy, namely India, using firm level data for the period 1994–2006. We disentangle different spillover channels, namely the demonstration effect, the imitation effect (R&D spillover) and a proxy to measure spillover effects coming from higher MNEs’ skills. We also account for the heterogeneous technological behaviour of local firms considering how in-house R&D efforts and disembodied technological imports may affect the exporting performance. Our findings show how export spillover effects are mainly mediated by an imitation effect, contrary to the case of other emerging market economies like China, where a demonstration effect is evident. We also recognise that both the decision to export and export intensity are influenced most of all by the technological activities of local firms. Moreover, the findings of the analysis suggest that in-house R&D is more relevant than other external sources of technological knowledge such as disembodied technology imports to internalise the positive spillover effect emanating from MNEs.     

Product market objectives and the formation of research joint ventures

In this paper we extend the existing literature on research and development (R&D) investments and research joint ventures (RJVs) in two important ways. First, we analyze and compare the case where firms collude in the product market to the benchmark case of competition in the output market. Second, we allow firms to form coalitions endogenously as a separate stage in the game. We develop profit functions that depend on the partition of firms into joint ventures and the nature of product competition between venture partners. Our results illustrate the restrictive nature of some assumptions made in the literature. Typically multiple RJVs of different sizes form in equilibrium. In general, RJVs should not be promoted if they entail product market collusion. Given the information available to policy‐makers, it is unlikely that an R&D policy more refined than analyzing and allowing RJVs on a case‐by‐case basis is feasible. Copyright © 1999 John Wiley & Sons, Ltd.     

Competing Research Joint Ventures

Research and development (R&D) competition among firms has recently been extended to R&D competition involving research joint ventures. It was previously shown that in an industry conducting cost-reducing R&D followed by competition in the product market, if all firms both fully share R&D information and coordinate investments to maximize pint profits, final products prices are lower, and firms' profits are higher than with information shriving alone, joint profit maximization alone, or no cooperation. In this paper we question whether a single research joint venture (RJV) cartel is the best form of industry R&D coordination. We show that there are circumstances in which splitting a single RJV cartel into several competing ones yields lower product prices. Moreover, we show that in these circumstances, splitting the industry into exactly two competing RJV cartels would be best.     

Knowledge Networks and Careers: Academic Scientists in Industry–University Links*

abstract Careers are central to our understanding of the knowledge creation dynamics of network organizations. Based on the example of R&D project collaboration between firms and universities, this paper examines the emerging forms of career models that support knowledge flows between organizations. It explores how some large firms in the high‐technology sectors have sought to break away from the limitations of internal R&D and firm‐based careers for scientists by engaging in external collaborative projects to gain access to the open knowledge networks of university researchers. It examines how the firms seek to forge close institutional ties with their university partners and develop network career structures in order to engage academic scientists in joint knowledge production. It argues that firms have sought to extend their human resource and knowledge boundaries into the established internal labour markets of the universities with which they collaborate, leading to the formation of a pool of joint human resources with work experiences and career patterns straddling the two sectors. The paper develops the concept of an ‘overlapping internal labour market’ to provide a conceptual bridge between internal labour markets and network organizations.     

The differential effects of public R&D support on firm R&D: Theory and evidence from multi-country data

This paper aims to evaluate the effects of various forms of public research and development (R&D) support on firms’ incentives to invest in R&D. First, in order to identify potential channels through which public R&D support influences firm R&D, a formal model of firm R&D with public R&D support is developed and analyzed. Four potential channels are identified: the technological-competence-enhancing effect, the demand-creating effect, the R&D-cost-reducing effect and the (project) overlap (or duplication) effect. These multiple channels indicate that it is difficult to evaluate the aggregate effect of public R&D support and that there are differential effects of public R&D support on firm R&D, depending on various firm- or industry-specific characteristics. Second, the differential effects of public R&D support are empirically tested using unique firm-level data for nine industries across six countries. Public support tends to have a complementarity effect on private R&D for firms with low technological competence, for firms in industries with high technological opportunities and for firms facing intense market competition. In contrast, firms with high technological competence and firms that have enjoyed fast demand growth in recent years show a crowding-out effect, and firm size and age do not show any discernible differential effect.     

Strategic R&D Location by Multinational Firms: Spillovers, Technology Sourcing, and Competition

This paper develops a model of strategic interaction in R&D internationalization decisions between two multinational firms, competing both abroad and in their home markets. It examines different incentives for foreign R&D faced by a technology leader and a technology laggard. The model takes into account the impact of local inter firm R&D spillovers, (noncostless) international intra firm transfer of knowledge, and the notion that internal R&D increases the effectiveness of incoming spillovers. Analytical results suggest that greater efficiency of intra firm transfers and greater R&D spillovers increase the attractiveness of domestic R&D for the technology leader if the technology gap with the laggard is large. The lagging firm, in contrast, increases the share of foreign R&D as foreign technology sourcing becomes more effective. Competition encourages the leading firm to engage in foreign R&D to capture a larger share of profits on the foreign market, whereas the laggard concentrates more R&D at home to defend its home market position.     

An analysis of firm-level innovation strategies in the US biotechnology industry

This study examines factors that may affect innovation strategies and performance of firms in the biotechnology industry. Specifically, differences between factors common to firms with high R&D intensity and those to firms with low R&D intensity are investigated. Biotechnology firms with relatively higher levels of R&D intensity attribute their innovation performance to research-based innovation factors and strategies such as strengthening their own research capabilities, entering into research collaborations with universities, industry leaders and other biotech firms, and licensing their technology. These strategies can be summarized as alignment within the industry. Firms with relatively lower R&D intensity have a hybrid focus—they invest in R&D but may also have products on the market. These firms attribute their innovation performance more so to production-based innovation factors and strategies such as gaining market access and maintaining connections with customers. Their strategy focuses on competitiveness, marketing, and distribution channels, while not ignoring the importance of a strong research base and the need to advance technologically. In a sense, strategies employed to achieve successful innovation reflect the stage of innovation in which a firm is operating for a particular product or process.     

IS FINANCIAL SUPPORT FOR PRIVATE R&D ALWAYS JUSTIFIED? A DISCUSSION BASED ON THE LITERATURE ON GROWTH

Many economists have long held that market failures create a gap between social and private returns to research and development (R&D), thereby limiting private incentives to invest in R&D. However, this common belief that firms significantly underinvest in R&D is increasingly being challenged, leading the rationale behind public support for private R&D to be questioned. In this paper, we attempt to clarify the perspectives of two sources: the theoretical literature on endogenous growth, and its recent developments in integrating a geographical dimension, and the empirical literature that measures the social returns to R&D in relation to the private returns. Ultimately, we are able to clearly distinguish among different types of market failures and compare their relative impact on the gap between the private and social returns to R&D. Two main conclusions are reached. First, systematic firm underinvestment in R&D is not demonstrated. Second, even though instances of underinvestment do occur, they are mainly explained by surplus appropriability problems rather than by knowledge externalities. This suggests the need for a new policy mix that employs more demand‐oriented instruments and is more concentrated on identifying efficient allocations among activities rather than merely increasing global private R&D investment.     

How does R&D intensity influence firm explorativeness? Evidence of R&D active firms in four advanced countries

Despite R&D is seen as a starting point of innovation, firms usually confront a trade-off in allocating limited R&D resources to either exploratory or exploitative activities. Relative to the latter, the former produces a more distinctive variation from the prior knowledge base and helps the firm tap into new opportunity. Given the increasing importance of firm explorativeness in the fast changing environments, the influence of R&D investment on firm explorativeness is not yet conclusive in the literature, not to mention whether the increased R&D investment induces firms to become more explorative. This study aims to generate insight into how and when firm explorativeness is determined by their R&D intensity. As a notion of the use of knowledge new to the organization, firm explorativeness is treated as the degree of using knowledge new to the organization in the pursuit of innovation. Based on a panel data of 1267 firm-year observations in four advanced countries during 1999–2003, the results reveal that a higher level of R&D intensity makes firms more exploitative and less explorative. Nevertheless, the negative relationship between R&D intensity and firm explorativeness is found to be alleviated in the presence of technological opportunity or financial slack. The configurational model sheds further light on the combined and relative weight of two moderators.