Do Innovations Really Pay Off? Total Stock Market Returns to Innovation

Abstract

Critics often decry an earnings-focused short-term orientation of management that eschews spending on risky, long-term projects such as innovation to boost a firm's stock price. Such critics assume that stock markets react positively to announcements of immediate earnings but negatively to announcements of investments in innovation that have an uncertain long-term pay off. Contrary to this position, we argue that the market's true appreciation of innovation can be estimated by assessing the total market returns to the entire innovation project. We demonstrate this approach via the Fama-French 3-factor model (including Carhart's momentum factor) on 5,481 announcements from 69 firms in five markets and 19 technologies between 1977 and 2006. The total market returns to an innovation project are $643 million, more than 13 times the $49 million from an average innovation event. Returns to negative events are higher in absolute value than those to positive events. Returns to initiation occur 4.7 years ahead of launch. Returns to development activities are the highest and those to commercialization the lowest of all activities. Returns to new product launch are the lowest among all eight events tracked. Returns are higher for smaller firms than larger firms. Returns to the announcing firm are substantially greater than those to competitors across all stages. We discuss the implications of these results.