Innovation Search Strategy and Predictable Returns

Tristan Fitzgerald (), Benjamin Balsmeier (), Lee Fleming () and Gustavo Manso ()
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Tristan Fitzgerald: Mays Business School, Texas A&M University, College Station, Texas 77843
Benjamin Balsmeier: Center for Research in Economics and Management (CREA), University of Luxembourg, 1359 Luxembourg
Lee Fleming: Coleman Fung Institute for Engineering Leadership, University of California, Berkeley, Berkeley, California 94720; Haas School of Business, University of California, Berkeley, Berkeley, California 94720
Gustavo Manso: Haas School of Business, University of California, Berkeley, Berkeley, California 94720

Management Science, 2021, vol. 67, issue 2, 1109-1137

Abstract: Because of the intangible and highly uncertain nature of innovation, investors may have difficulty processing information associated with a firm’s innovation search strategy. Due to cognitive and strategic biases, investors are likely to pay more attention to unfamiliar explorative patents rather than incremental exploitative patents. We find that innovative firms focusing on exploitation rather than exploration tend to generate superior subsequent short-term operating performance. Analysts do not seem to detect this, as firms currently focused on exploitation tend to outperform the market’s near-term earnings expectations. The stock market also seems unable to accurately incorporate information about a firm’s innovation search strategy. We find that firms with exploitation strategies are undervalued relative to firms with exploration strategies and that this return differential is incremental to standard risk and innovation-based pricing factors examined in the prior literature. This result suggests a more nuanced view on whether stock market pressure hampers innovation, and may have implications for optimal firm financing choices and corporate disclosure policy. This paper was accepted by David Simchi-Levi, finance.

Keywords: exploration; exploitation; patents; innovation; market efficiency; limited attention (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (17)

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