Innovation activity and corporate financing: evidence from a developing economy

Abstract

The present study investigates the extent to which technology-related asymmetric information between corporate managers and outside investors has an adverse effect on the external financing activities of innovation-intensive firms. The results indicate that innovation-intensive firms are more likely to engage in equity financing when their valuation multiples are higher than those of their industry peers. This finding is more pronounced among firms with low institutional shareholdings and fewer brokers following them. The empirical evidence supports the misvaluation explanation, as well as the timing and type of security issuance if the agency problem is severe. The findings provide insights into the timing of company financing choices in a highly innovative developing economy.

Keywords:

• innovation activity
• patents
• external financing
• capital markets

JEL Classification::

• N25
• M21
• M40

Notes

¹ Hirshleifer et al. (2011) argue that information about new technologies is hard for investors to process as it requires knowledge about how the economic fundamentals are changing. It also requires the analysis of the innovation process, from new ideas to final products on the market, as the expected profit of such activities is highly uncertain.

² For instance, Taiwanese companies are major global suppliers of made-to-order chips (e.g. Taiwan Semiconductor Manufacturing Co.) and manufacturers of DRAM memory chips (e.g. Mosel Vitelic Inc. and Winbond Eletronics Co.).

³ Others, such as Li (2011), show that the return predictability of R&D exists mainly in financially-constrained firms and that R&D-intensive firms incur greater systematic risks when they are financially constrained.

⁴ Not all inventions result in patents and a firm may choose other methods or mechanisms, such as copyrights, trademarks, secrecy and lead-time advantages, to protect its intellectual property from competitors (Deng et al., 1999). Nevertheless, the quantity of patents granted has been widely adapted to measure innovation performance.

⁵ Additional analyses using measures of external financing based on balance sheet accounts, using changes in the relevant equity and debt accounts, provide qualitatively similar results.

⁶ As a robustness check, I exclude the years 2007 and 2008 to avoid the potential impact of the financial crisis on the stock market in Taiwan. Untabulated results lead to the same conclusions.