52 Pages Posted: 21 Nov 2013 Last revised: 13 Jul 2020
Date Written: April 20, 2020
This paper documents that underpriced firms substitute R&D spending with share buybacks to the detriment of innovation. To identify underpriced firms, I introduce a novel measure of non-fundamental price pressure induced by indirect exposure to industry-level shocks. This measure addresses potential shortcomings of common proxies of underpricing based on flow-induced fire sales. The documented negative impact on R&D is stronger for financially constrained firms that are held by impatient investors, and for high-disagreement stocks. The results are consistent with a model in which managers under-invest in innovation to boost short-term profits, as the market is inefficiently slow in valuing research.
Keywords: innovation, research, underpricing, share repurchases, mutual funds, firm policies, impatience
JEL Classification: G12, G31, G35, O31
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