Prior research shows that corporate innovation enhances firm value. Using a novel text-based measure of corporate innovation, we explore how the effects of corporate innovation on firm performance change in the presence of economic policy uncertainty. We use a large sample of US firms over the period 1996 to 2010 to test the relationship by executing firm-fixed effect regressions. Our results show that corporate innovation significantly positively affects firm performance. However, our results also reveal that the favorable effect of corporate innovation on firm value is reduced substantially in times of greater economic policy uncertainty. The latter result highlights the urgent need for policymakers to maintain the long-term consistency of economic policies to encourage firms’ innovative activities. Several robustness checks including three proxies for firm performance and four instrumental-variable analyses confirm our original results. JEL Classification: E66, O31, G32
Although the role of managers is crucial in shaping firm innovation, it also poses a dilemma. Because innovation is a complicated and long-term process that requires effort and attention, managers may reduce effort in innovation when faced with high takeover threat. This study examines the effects of hostile takeover threats on managerial efforts to innovate. Our results show that more active hostile takeover markets stifle managerial efforts in corporate innovation. The findings suggest that managers tend to be more myopic when firms are exposed to hostile takeover threats. Managers will put less effort into innovation to counter the risk of being dismissed as the expected payoff from such investment is long-term and highly uncertain. Additional robustness checks confirm the results, including random-effects regressions, an alternative measure of innovation, and two instrumental-variable analyses.
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