When is Good News Not Good News? Opening Up the Black Box of Innovation for Family Firms

Massimo Massa, Po-Hsuan Hsu, Sterling Huang and Hong Zhang

No 11472, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper examines the incentives for family firms to innovate. We argue that, due to the wealth concentration of major shareholders, family firms are incentivized to diversify their risk through innovation. In particular, family firms use innovation to explore new (as opposed to existing) fields of business. Using a comprehensive sample of U.S. family-owned public firms and patents for the period from 1998 to 2010, we confirm that family ownership is positively (negatively) related to exploratory (exploitative) innovation. Tests based on instrumental variables regression (divorce laws of family firms’ headquarter states or neighboring states) and regulatory shocks in inheritance taxes further offer a causal interpretation. Market prices, however, respond negatively to family firms’ exploratory innovation, suggesting that such innovation may benefit major shareholders of family firms at the cost of minority shareholders. Our results suggest that risk-mitigation incentives play an important role in affecting innovation strategies, which may have subtle implications for investors in financial markets.

Keywords: Family firms; Innovation; Under-diversification; Innovation strategies (search for similar items in EconPapers)
JEL-codes: G32 O32 (search for similar items in EconPapers)
Date: 2016-08
New Economics Papers: this item is included in nep-ino and nep-sbm
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