Does Stock Market Boost Firm Innovation? Evidence from Chinese Firms

Abstract

We investigate the effect of stock market on firm innovation via the len of initial public offering (IPO) using a uniquely matched Chinese firm-level data. Using the difference-in-difference approach, together with the propensity score matching algorithm to construct the treatment and control group, we find that the IPO leads to an increase in both quantity and quality of firm innovation activity. In addition, IPO expands a firm’s scope of innovation beyond its core business. The impact of IPO on firm innovation varies across corporate governance structure. We find that the increase in innovation can be attributed to the fact that the IPO helps to relax the credit constraint that a firm faces before the IPO. Therefore a firm can allocate more resource to innovation through retaining internal inventors and hiring more inventors after the IPO. Finally, we show that the enhanced innovation activity helps a firm create value, indicated by an increase in Tobin’s Q.

Keywords: Innovation, IPO, Capital market, Tobin's Q