Innovation and the Market Value of UK Firms, 1989–1995*

Oxford Bulletin of Economics and StatisticsVolume 64, Issue 1 p. 39-61 Innovation and the Market Value of UK Firms, 1989–1995* Otto Toivanen, Otto Toivanen Helsinki School of Economics Warwick Business School Manchester School of ManagementSearch for more papers by this authorPaul Stoneman, Paul Stoneman Helsinki School of Economics Warwick Business School Manchester School of ManagementSearch for more papers by this authorDerek Bosworth, Derek Bosworth Helsinki School of Economics Warwick Business School Manchester School of ManagementSearch for more papers by this author Otto Toivanen, Otto Toivanen Helsinki School of Economics Warwick Business School Manchester School of ManagementSearch for more papers by this authorPaul Stoneman, Paul Stoneman Helsinki School of Economics Warwick Business School Manchester School of ManagementSearch for more papers by this authorDerek Bosworth, Derek Bosworth Helsinki School of Economics Warwick Business School Manchester School of ManagementSearch for more papers by this author First published: 17 September 2008 https://doi.org/10.1111/1468-0084.00002Citations: 114 † The research reported upon in this paper has been financed by the Economic and Social Research Council as part of a larger project on Intellectual Property Rights (Company Performance and the Value of Intellectual Property, ESRC grant number L325253005). The first author's research was also funded by the Academy of Finland and the Yrjo Jahnsson foundation, which he would like to thank for support. Parts of this work were carried out while the first author was visiting MIT and NBER, whose hospitality is gratefully acknowledged. Particular thanks are due to the UK Patent Office, which provided UK patent information on CD, and to Mark Longland for compiling the data set used in the present study. Thanks also to Christine Greenhalgh for comments on various drafts of the paper and to an anonymous referee. Any remaining errors are the responsibility of the authors. ‡ For a more sanguine view of why market value and innovativeness may not be related because of information problems and accounting standards see Amir and Lev (1996) and Lev and Sougiannis (1996). § Whether this is a true measure of the contribution of such assets to company performance is of course dependent on the assumption of capital market effi 2;ciency. Although there is a substantial and largely unresolved literature on this issue (e.g. Timmerman, 1994, Satchell and Damant, 1995, Miles, 1993 and 1995) there is a widely held view that capital markets are amongst the more efficient of markets. However it is commonly argued that UK equity markets are short termist in which case the estimated impact of R&D on market value will be a downward biased estimate of the true impact on company performance. This issue is discussed further in section 5. ¶ Hall (1992) points out the size of the errors that can be introduced through this approximation. In the estimation below we have checked whether omitting the approximation and using nonlinear least squares has any significant effect on our results. We find that it does not. ‖ Bosworth and Mahdian (1999) find evidence that R&D, patents and trademarks all play a significant role in explaining the market value of UK pharmaceutical companies. † † Including risk, the one variable not included here but commonly found in the US studies reviewed by Hall (2000) although not by Hall (1993a, b) herself. ‡ ‡ In addition, we have experimented with the inclusion of terms that measure the R&D intensity of the industry in which the firm is located. Such variables were included in order to pick up possible spill-over effects of innovation from one firm to another or, alternatively, competitive effects between firms or, finally, analysts' valuation of companies on the basis of their R&D intensity relative to that of other firms in the industry. A number of studies in the literature have suggested that such effects may be important e.g. Jaffe (1986) and Megna and Klock (1990). In our own results, however, the inclusion of such variables did not improve the performance of the specification (a result broadly consistent with Geroski (1994), which reports a lack of apparent spillover effects in the UK) and, thus, such terms are not further discussed in this paper. § § A closely related literature (e.g. Zantout and Tsetsekos, 1994) also indicates that “surprise” announcements of increased R&D spending significantly positively impact upon market valuation. ¶ ¶ Around 1 in 5 of our companies are likely to be (partially owned) subsidiaries of foreign parents. This raises some issues if the R&D is located in the parent and not in the UK subsidiary for the market value of the subsidiary may be higher because of innovation assets generated outside the subsidiary. Such effects can be picked up to some degree by the firm specific fixed effects in the panel data estimates below, but to the extent that they do exist would tend to bias downwards our direct coefficient estimates of the impact of R&D on market value. ‖ ‖ At the time of constructing the sample, very few companies reported their UK accounts other than in pounds sterling, and it was not clear why a small number of companies chose to report in other currencies. More recently, however, some large companies have started to report in either US$ or Euros – so we would not apply such a restriction when up-dating the data. † † † A large proportion of the firms operate in several industries, but we were not able to compile detailed data on how a given firm's sales are spread over industries. ‡ ‡ ‡ Market share of firm i in period t is defined as firm i's proportion of industry sales in period t, within our sample. § § § The one existing method for estimating panel data models with endogenous sample selection ( Kyradzidiou, 1997) relies on first differencing the data. However as is well known, the signal to noise ratio in variables such as R&D is low and thus first differencing leads to a loss of information. ¶ ¶ ¶ We also experimented with estimating the market value equations in first difference form however in general the results were poor. We consider that this is largely because the signal to noise ratio in variables such as R&D is low and the use of first differencing leads to a loss of information. ‖ ‖ ‖ The results present a slight puzzle with respect to “new news”. The coefficient on the Mills ratio was insignificantly different from zero in the market valuation equation suggesting that firms that do not declare their R&D spend are valued in a similar manner to those that do. On the other hand, we find that when a firm declares R&D for the first time, the market values this more highly than an equivalent amount of R&D reported year on year. These results do not appear consistent. 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