"Innovation Search Strategy and Predictable Returns" (with Benjamin Balsmeier, Lee Fleming and Gustavo Manso)
(2021) Management Science 67(2): 1109-1137
Abstract: Due to cognitive and strategic biases, we hypothesize that investors are likely to pay more attention to unfamiliar explorative patents rather than incremental, exploitative patents. We find that firms focusing on exploitation rather than exploration tend to generate superior subsequent 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 strategy information. We find that firms pursuing exploitative innovation search strategies are undervalued relative to firms following exploration strategies and that this return differential is incremental to standard risk and innovation-based pricing factors examined in the prior literature.
"Unconstrained estimates of the equity risk premium" (with Stephen Gray, Jason Hall and Ravi Jeyaraj)
(2013) Review of Accounting Studies 18: 560-639
Abstract: Estimates of the equity risk premium implied by analyst forecasts - generally 2-4% - are often significantly below realized equity returns of 6%. Measurement error could result from conservative assumptions, reliance upon consensus rather than detailed forecasts, the use of market rather than target prices, and regression analysis, which can be influenced by outliers. We address these potential sources of measurement error. Our estimates are consistent with subsequently realized returns and capture systematic risk exposure. From 1999 to 2008, we estimate an average U.S. equity risk premium of 5.3%. The estimate increases from 3.1% for 1999–2000 to 5.9% from 2001–2008, comparable to past returns.
Working Papers
"Shared Culture and Technological Innovation: Evidence from Corporate R&D Teams" (with Xiaoding Liu)
Revise and resubmit (R&R) at Journal of Financial Economics
Abstract: We open the black box of firm innovation production by examining its most important input: the teams of employees tasked with creating new inventions. Using a novel within-firm research design that tracks the universe of U.S. corporate inventors and their teams across four decades, we find that inventors’ shared cultural values are a critical driver of inventor team formation. Moreover, using premature co-inventor deaths as exogenous shocks to team composition, we document both positive and negative impacts of inventor team cultural diversity on team patent production. Less culturally diverse teams produce a higher overall quantity of patents that tend to exploit existing technologies, while more culturally diverse teams produce more risky, exploratory patents with a greater potential for high-impact innovations. Exploring the underlying mechanisms, we present micro-level evidence that culturally diverse teams tend to seek new knowledge from more heterogeneous and non-traditional input information sources, but they also face greater knowledge integration challenges. Overall, our results present a more nuanced perspective on diversity, revealing that it does not lead to uniformly better or worse outcomes, but instead impacts the type of economic output.
"How do Venture Capitalists (Actually) Make Decisions? Internal Evidence from a Private Startup Accelerator" (with Korok Ray)
Abstract: Using a confidential dataset detailing all startup applications, all internal judging scores, and all financial contracts signed by one of the largest venture capital-backed startup accelerators in the United States, we seek to open the ‘black box’ of venture capital (VC) decision-making. We first examine the internal VC investment selection process by focusing on how individual VC partners/employees evaluate the same potential portfolio firm. We provide novel evidence on the existence of significant VC judge-founder ‘homophily’ biases and detail how different judging settings (e.g., solo vs. group evaluations; availability of quantitative vs. qualitative information) can amplify or mitigate such biases. Next, we document the features of a recent innovation in startup firm financial contracting instruments (namely Simple Agreement for Future Equity (SAFE) and Keep It Simple Security (KISS) contracts) and investigate their relationship with startup firm characteristics and internal VC evaluations. We offer novel empirical insights into the role of a salient ‘anchor’ or ‘reference point’ in setting future equity pricing terms as well as the importance of startup financial constraints in VC term sheet negotiations.
"Til Death Do Us Part: The Relative Merits of Founder CEOs"
Abstract: A question that is constantly faced by every firm in the economy is when is it optimal for a firm’s founder to lead the company as CEO? To identify the causal effect of founder CEOs on firm outcomes, I exploit a novel natural experiment that compares firms that experience an exogenous, health-related founder-to-professional CEO turnover with equivalent firms that can retain their founder CEO. I first find that founder CEOs and professional CEOs have distinct yet valuable skill sets. While founder CEOs promote higher internally generated innovation output than professional CEOs, professional CEOs counteract this reduced internal R&D productivity by undertaking other value enhancing activities, including acquiring external technologies through greater M&A activity, increasing firm leverage, and nurturing larger, more stable top management teams. I then show that the aggregate effect of these different strategies on total firm value depends on the firm’s level of technological complexity and life cycle stage.
"Financial Contracting for Innovation: Property Rights in Action"
Abstract: In property rights theory, financial contracting structures can align property rights to promote entrepreneurial firm innovation. I first provide novel estimates that strategic alliances have 6% to 11% higher overall innovative success rates compared to corporate VC and independent VC, respectively. Then, using a matched quasi-experiment in clinical trials to decompose selection (endogenous matching) and treatment effects, I find that strategic alliances promote 5% higher overall innovative success rates than both CVC and IVC (33% change in relative terms). I map the underpinnings of alliance success to the mechanisms of knowledge sharing and willingness to support costly experimentation.