Misvaluing Innovation

56 Pages Posted: 15 Mar 2011 Last revised: 5 Apr 2016

See all articles by Lauren Cohen

Lauren Cohen

Harvard University - Business School (HBS); National Bureau of Economic Research (NBER)

Karl B. Diether

Independent

Christopher J. Malloy

Harvard Business School; National Bureau of Economic Research (NBER); Arrowstreet Capital, LP

Date Written: July 14, 2012

Abstract

We demonstrate that a firm’s ability to innovate is predictable, persistent, and relatively simple to compute, and yet the stock market ignores the implications of past successes when valuing future innovation. We show that two firms that invest the exact same in research and development (R&D) can have quite divergent, but predictably divergent, future paths. Our approach is based on the simple premise that while future outcomes associated with R&D investment are uncertain, the past track records of firms may give insight into their potential for future success. We show that a long-short portfolio strategy that takes advantage of the information in past track records earns abnormal returns of roughly 11 percent per year. Importantly, these past track records also predict divergent future real outcomes in patents, patent citations, and new product innovations.

Keywords: Innovation, track records, return predictability, patents, asset pricing

JEL Classification: G12, G14, O32

Suggested Citation

Cohen, Lauren and Diether, Karl B. and Malloy, Christopher J., Misvaluing Innovation (July 14, 2012). AFA 2012 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1785454 or http://dx.doi.org/10.2139/ssrn.1785454

Lauren Cohen (Contact Author)

Harvard University - Business School (HBS) ( email )

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HOME PAGE: http://www.people.hbs.edu/lcohen

National Bureau of Economic Research (NBER) ( email )

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Karl B. Diether

Independent

Christopher J. Malloy

Harvard Business School ( email )

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Baker Library 277
Boston, MA 02163
United States
617-495-4383 (Phone)

National Bureau of Economic Research (NBER) ( email )

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Arrowstreet Capital, LP ( email )

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Cambridge, MA 02138
United States

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