Innovation Search Strategy and Predictable Returns

Management Science, Forthcoming

60 Pages Posted: 7 Aug 2019

See all articles by Tristan Fitzgerald

Tristan Fitzgerald

Texas A&M University - Department of Finance

Benjamin Balsmeier

KU Leuven - Department of Managerial Economics, Strategy, and Innovation

Lee Fleming

Harvard University - Technology & Operations Management Unit

Gustavo Manso

University of California, Berkeley - Haas School of Business

Date Written: August 2, 2019

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.

Keywords: Innovation, Exploration, Exploitation, Patents, Market Efficiency, Limited Attention

JEL Classification: G12, G14, O32

Suggested Citation

Fitzgerald, Tristan and Balsmeier, Benjamin and Fleming, Lee and Manso, Gustavo, Innovation Search Strategy and Predictable Returns (August 2, 2019). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3432059

Tristan Fitzgerald (Contact Author)

Texas A&M University - Department of Finance ( email )

430 Wehner
College Station, TX 77843-4218
United States

HOME PAGE: http://https://sites.google.com/site/tristanjfitzgerald/

Benjamin Balsmeier

KU Leuven - Department of Managerial Economics, Strategy, and Innovation ( email )

Naamsestraat 69 bus 3500
Leuven, 3000
Belgium

Lee Fleming

Harvard University - Technology & Operations Management Unit ( email )

Boston, MA 02163
United States
617 495 6613 (Phone)
617 496 5265 (Fax)

Gustavo Manso

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

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