Firm innovation and institutional investment: the role of the Sarbanes–Oxley Act

Abstract

This paper investigates the effect of the Sarbanes-Oxley Act (SOX) on the relation between institutional ownership (IO) and firm innovation. We find that US firms investing in innovation attract more institutional capital post-SOX. Prior literature identifies two SOX effects on the average US firm that could drive this relation, that is, a decreased level of information asymmetry (direct effect) and the consequent increased market liquidity (indirect effect). Our findings overwhelmingly support the direct effect. In particular, we find that the positive relation between IO and innovation post-SOX is mainly driven by passive and dedicated institutional investors. These investors benefit greatly from a reduction in the firm's information asymmetry but receive little gain from improvements in market liquidity, given their long-term trading horizon. Our results are robust to different model specifications, including difference-in-differences tests, which alleviate concerns about the impact of confounding effects on our conclusions. Taken together, our findings indicate an important policy effect of SOX, namely, the strengthening of institutional investor support for firm innovation. Downloaded by [University of Otago] at 23:54 15 July 2015 72 N. Abdioglu et al. (Bushee 1998;Lang and McNichols 1997;Porter 1992), as far as we are aware none of the existing studies has examined the SOX effect on the relation between IO and firm innovation. We contribute to the literature by examining whether a policy, specifically the SOX enactment, has altered institutional investors' investment preferences regarding firm innovation. Specifically, our main research question is the following: Have highly innovative firms attracted more institutional investment since the enactment of SOX? We predict that the reduced information asymmetry and/or increased liquidity in the US market will strengthen the relation between IO and innovation. In other words, we expect highly innovative firms to attract more institutional investment post-SOX.Consistent with our prediction, we find that highly innovative firms do attract more institutional investment post-SOX. Both our univariate and multivariate analyses highlight a strong SOX effect. In order to investigate which of the two effects, that is, the reduced information asymmetry or the increased market liquidity, drives our results, we conduct the following analyses: First, we separate institutional investors into active and passive groups and investigate their investment preferences separately. 1 Passive institutional investors typically avoid investing in firms with high information asymmetry since the cost of monitoring is too high for them, compared to the cost for active investors. A reduction in the value of private information post-SOX would favour the passive investors greatly, since their competitive disadvantage (compared to active investors) would be lower. So, given the SOX-led reduction in information asymmetry levels, highly innovative firms should be able to attract more passive inst...

Debt maturity and corporate R&D investment – the empirical study of US listed firms

“…Note: *, **, and *** represent statistical significance at the 10%, 5%, and 1% levels, respectively. equation (1), bank debt is positively related to firm R&D investment as confirmed in column (1) of Table 4. The coefficient is significant and even higher compared to that in Table 3.…”

“…The first-stage results generated the estimated values of BANKDEBT_TA and PUBLICDEBT_TA as reported in columns (1) and (2). Column (3) reports the second stage of 2SLS estimation results of R&D investment (RD_TA) on bank debt and public debt in equation (1). The test of weak instruments examines the null hypothesis that the instruments are weak at the 5% level of significance.…”

“…The regression is specified as equation (1) ed by the total assets. An estimated model is first built for BANKDEBT_TA and PUBLICDEBT_TA using the above instrumental variables and all the control variables in equation (1). The models are shown as equations (2) and (3)…”

“…See Table 1a for variable definitions. Columns (1) and (2) show the results of the estimated model for BANKDEBT_ TA and PUBLICDEBT_TA using the above instrumental variables and all control variables in equation (1). Hausman test for endogeneity:…”

“…Since most previous studies on financing corporate innovation focus on internal financing or equity channels, very few papers mentioned debt financing. Among corporations with external financing, the amount of debt has exceeded the equity 1 . Given the economic importance of debt in allocating capital to firms, an emerging stream of research explores the relationship between leverage and investment decisions.…”