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Innovation Search Strategy and Predictable Returns

Author

Listed:
  • Tristan Fitzgerald

    (Mays Business School, Texas A&M University, College Station, Texas 77843)

  • Benjamin Balsmeier

    (Center for Research in Economics and Management (CREA), University of Luxembourg, 1359 Luxembourg)

  • Lee Fleming

    (Coleman Fung Institute for Engineering Leadership, University of California, Berkeley, Berkeley, California 94720; Haas School of Business, University of California, Berkeley, Berkeley, California 94720)

  • Gustavo Manso

    (Haas School of Business, University of California, Berkeley, Berkeley, California 94720)

Abstract

Because of the intangible and highly uncertain nature of innovation, investors may have difficulty processing information associated with a firm’s 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 innovative 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. This paper was accepted by David Simchi-Levi, finance.

Suggested Citation

  • Tristan Fitzgerald & Benjamin Balsmeier & Lee Fleming & Gustavo Manso, 2021. "Innovation Search Strategy and Predictable Returns," Management Science, INFORMS, vol. 67(2), pages 1109-1137, February.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:2:p:1109-1137
    DOI: 10.1287/mnsc.2019.3480
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    Citations

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    Cited by:

    1. Raffaele Morandi Stagni & Andrea Fosfuri & Juan Santaló, 2021. "A bird in the hand is worth two in the bush: Technology search strategies and competition due to import penetration," Strategic Management Journal, Wiley Blackwell, vol. 42(8), pages 1516-1544, August.
    2. Tseng, Kevin, 2022. "Learning from the Joneses: Technology spillover, innovation externality, and stock returns," Journal of Accounting and Economics, Elsevier, vol. 73(2).
    3. Haochuan Cui & Tiewei Li & Cheng-Jun Wang, 2023. "Climbing up the ladder of abstraction: how to span the boundaries of knowledge space in the online knowledge market?," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-12, December.
    4. Zhong, Xi & Chen, Weihong & Ren, Ge, 2022. "The effects of performance shortfalls on firms’ exploitation and exploration R&D internationalization decisions: Does industry environmental matter?," Technovation, Elsevier, vol. 112(C).
    5. Shu, Tao & Tian, Xuan & Zhan, Xintong, 2022. "Patent quality, firm value, and investor underreaction: Evidence from patent examiner busyness," Journal of Financial Economics, Elsevier, vol. 143(3), pages 1043-1069.
    6. Baig, Ahmed & Butt, Hassan Anjum & Fitwi, Abrar & Smith, Joey, 2021. "Does Innovation Explain the Skewness of Stock Returns?," American Business Review, Pompea College of Business, University of New Haven, vol. 24(2), pages 12-31, November.
    7. Jeongsik “Jay” Lee & Hyun Ju Jung & Hyunwoo Park, 2023. "Rare is beautiful? Rareness, technology value, and the moderating role of search domain and knowledge maturity," Production and Operations Management, Production and Operations Management Society, vol. 32(4), pages 1019-1040, April.
    8. Zhang, Tianyu, 2022. "Independent directors and patenting strategies: Evidence from China," International Review of Financial Analysis, Elsevier, vol. 81(C).
    9. Rajaiya, Harshit, 2023. "Innovation Success and Capital Structure," Journal of Corporate Finance, Elsevier, vol. 79(C).
    10. Tan, Youchao & Liu, Xiumei & Sun, Hanwen & Zeng, Cheng(Colin), 2022. "Population ageing, labour market rigidity and corporate innovation: Evidence from China," Research Policy, Elsevier, vol. 51(2).
    11. Lindsay Baran & Arno Forst & M. Tony Via, 2023. "Dual‐class share structure and innovation," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 46(1), pages 169-202, February.
    12. Steven Callander & Niko Matouschek, 2022. "The Novelty of Innovation: Competition, Disruption, and Antitrust Policy," Management Science, INFORMS, vol. 68(1), pages 37-51, January.
    13. Yuan Ni & Jia Wang & Cui Li, 2022. "The Power of Sustainability in the “Black Swan” Event: Entrepreneurial Cognition of Top Management Team and Dual Business Model Innovation," Sustainability, MDPI, vol. 14(6), pages 1-22, March.

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