Firm Innovation and Financial Analysis: How Do They Interact?

Entrepreneurs innovate more when financiers are better informed about their projects because they expect to receive more funding should their projects be successful. Conversely, financiers collect more information about projects when entrepreneurs innovate more because the opportunity cost of misinvesting, i.e. of missing out on successful projects, is higher. Thus, technological knowledge and knowledge about technologies are mutually reinforcing. We report evidence consistent with this interaction using two quasi-natural experiments that changed, respectively, the innovation incentives and the information environment for U.S. listed firms. A calibration suggests that its contribution to income growth represents more than one third of the total contributions of information collection and innovation. We also estimate that a policy designed to stimulate innovation has an indirect effect through investors’ learning incentives that accounts for a third of the total effect of the policy on firms’ innovation incentives.