The impact of innovation on firm value

by Alina Sorescu Assistant Professor of Marketing

Innovation is an engine of firm growth and an imperative to many firms. Managers are always seeking new ways to innovate better, faster and to increase the returns to innovation. Some of my current projects deal with understanding the sources and financial consequences of new product introductions.

Part of the impact of new products on firm value materializes even before these products reach the marketplace. Indeed, many firms preannounce the introduction of their new products. These preannouncements are viewed as strategic signals that firms direct at their customers, competitors, channel members and investors. Is the effectiveness of these signals acknowledged by the stock market?

My co-authors Venky Shankar, Tarun Kushwaha and I find that the financial returns from preannouncements are not significantly different from zero in the short-term, but are significantly positive in the long-term (about 13 percent in one year or up to product introduction). The short-term abnormal returns are positively related to how detailed the content of the preannouncement is, whereas the long-term abnormal returns are positively associated with how often the information released in the preannouncement is updated. Our results also show that the credibility of the preannouncing firm positively moderates these relationships.

Moving beyond the introduction date, what are the long term firm-level financial returns to new products?  Using a comprehensive database of over 20,000 new consumer packaged goods introduced over 19 years, Jelena Spanjol and I test the relative impact of various innovation strategies on firm value. We examine firms which appear focused on breakthrough innovations and firms which pursue incremental innovation. So far, research has suggested that the stock market expects some standard level of incremental innovation. Consequently, firms focusing just on incremental innovation should merely earn their cost of capital and their abnormal stock returns to innovation will be zero. 

Our findings — a lack of main effect of incremental innovations on stock returns — confirm this assumption. However, we show that incremental innovation performs a previously overlooked role: it enhances the value of breakthrough innovation. We find that breakthrough innovations lead to significantly greater long-term stock market returns, but only for firms that introduce them in conjunction with incremental innovations. We also examine the deployment of new products in the marketplace and we find that significant long-term stock market returns accrue to firms that dominate the innovation activity within product markets.

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