Capital Market Feedback and Corporate Innovation

Abstract

We investigate the effect of capital market feedback on corporate investment in innovation. To identify changes in firms' behavior in response to capital market feedback, we exploit the launch of the USPTO's Public Patent Application Information Retrieval (PAIR) system that made internal information about the patent application process publicly available. Consistent with the existence of feedback, we document that market reactions to patent grants change after the launch of the PAIR system. More importantly, variation in feedback correlates with firm behavior and predicts future investment in innovation as captured by project continuation decisions, patent renewals, and the direction of future patent applications. Firms that facilitate capital market feedback by making a larger fraction of application information publicly available also produce more valuable innovations in the future. Taken together, our results indicate not only that corporate investment in innovation is affected by capital market feedback, but also that the feedback effect is more pronounced the more information about the innovation process is publicly available.

Keywords: Capital market feedback; Corporate innovation; Corporate investment; Disclosure; Managerial learning

JEL Classification: D83, O30