Product Market Power and Technological Innovation

Abstract

Product market power serves as a natural hedge against adverse shocks and competitive threats, thus increasing managerial risk tolerance of innovation investment. Consistent with that, we find that product market power is positively associated with firm innovation input and output. Additionally, consistent with learning from the leader’s market valuation, we find that firm innovation is positively and significantly sensitive to market valuation of its product market leader, especially if the stock price of the leader/followers is more/less informative. The follower firms alter their R&D investments based on stock return around their leader’s patent grant dates. The followers mimic innovation investments of their product market leader and private information in leader’s prices is associated with improvement in their future profits. We find that liquidity shocks to leader’s stock price hamper the following firms’ learning. We conclude that product market power promotes innovation and firms learn from product market leader’s market valuation.

Keywords: Product market leader, learning, technological innovation, market valuation, accounting quality

JEL Classification: G14, G31, M41