Stock Prices, Investor Short-Termism, and Innovation

51 Pages Posted: 21 Nov 2014

See all articles by Huong T. T. Le

Huong T. T. Le

Northeastern Illinois University

Ji-Chai Lin

Hong Kong PolyU

Date Written: November 17, 2014

Abstract

Firms can change their outstanding shares to manage their stock price levels. Those with lower stock prices tend to attract more speculative trading, which causes higher price volatility and may force their managers to excessively focus on short-term earnings at the expense of R&D and other long-term projects. Thus, we hypothesize that firms investing more in R&D prefer to set higher stock prices to mitigate investor short-termism and foster innovation. Indeed, we find that firms with more R&D capital tend to keep higher stock prices and are less likely to split their stocks to lower prices. Furthermore, high-priced firms are less likely to cut R&D to reverse an earnings decline, and less likely to fire their CEOs in the presence of poor earnings. More importantly, firms’ R&D productivity — in terms of generating patents and patent citations — tends to increase with their stock prices, even after controlling for firm valuation, stock returns, stock liquidity, and institutional ownership. For robustness checks, we examine stock splits, which allow mangers to re-set their stock price levels, and IPOs in which managers set an offering price range before shares are publicly traded. Consistent with our hypothesis, we find that IPO firms setting higher offering prices have more future innovation and that innovation declines after firms split their stocks. Thus, our results imply that managers of R&D firms actively set high stock prices to foster innovation, and support Warren Buffett’s wisdom that firms can use stock prices to attract preferred clientele.

Keywords: Share price, innovation, institutional ownership, short-termism

JEL Classification: G12, G14, G23, O31

Suggested Citation

Le, Huong T. T. and Lin, Ji-Chai, Stock Prices, Investor Short-Termism, and Innovation (November 17, 2014). Available at SSRN: https://ssrn.com/abstract=2527994 or http://dx.doi.org/10.2139/ssrn.2527994

Huong T. T. Le (Contact Author)

Northeastern Illinois University ( email )

Chiago, IL 60625
United States

Ji-Chai Lin

Hong Kong PolyU ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

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