Acquiring innovation through M&A is subject to information frictions, as assessing the value of innovative targets is a challenging task. We find an inverted U-shaped relation between firm innovation and takeover exposure; equity usage increases with target innovation; and the deal completion rate drops with innovation. We develop and estimate a model of acquiring innovation under information frictions, featuring endogenous merger, innovation, and offer composition decisions. Our estimates suggest that acquirers’ due diligence reveals only 30% of private information possessed by targets. Eliminating information frictions increases capitalized merger gains by 59%, stimulates innovation, and boosts productivity, business dynamism, and social welfare

We propose that innovative originality is a valuable organizational resource and that owing to limited investor attention and skepticism of complexity, greater innovative originality may be undervalued. We find that firms' innovative originality strongly predicts higher, more persistent, and less volatile profitability and higher abnormal stock returns, findings that are robust to extensive controls. The return predictive power of innovative originality is stronger for firms with higher valuation uncertainty, lower investor attention, and greater sensitivity of future profitability to innovative originality. This evidence suggests that innovative originality acts as a "competitive moat" and is undervalued by the market

We show that wrongful discharge laws—laws that protect employees against unjust dismissal—spur innovation and new firm creation. Wrongful discharge laws, particularly those that prohibit employers from acting in bad faith ex post, limit employers' ability to hold up innovating employees after the innovation is successful. By reducing the possibility of holdup, these laws enhance employees' innovative efforts and encourage firms to invest in risky but potentially mould-breaking projects. We develop a model and provide supporting empirical evidence of this effect using the staggered adoption of wrongful discharge laws across U.S. states

We show that wrongful discharge laws—laws that protect employees against unjust dismissal—spur innovation and new firm creation. Wrongful discharge laws, particularly those that prohibit employers from acting in bad faith ex post, limit employers' ability to hold up innovating employees after the innovation is successful. By reducing the possibility of holdup, these laws enhance employees'innovative efforts and encourage firms to invest in risky but potentially mould-breaking projects. We develop a model and provide supporting empirical evidence of this effect using the staggered adoption of wrongful discharge laws across U.S. states

We develop a theory of innovation waves, investor sentiment, and merger activity based on Knightian uncertainty. Uncertainty-averse investors are more optimistic on an innovation when they can make contemporaneous investments in multiple uncertain projects. Innovation waves occur when there is a critical mass of innovative companies, and are characterized by stronger investor sentiment, higher equity valuation, and hot initial public offering markets. Our approach to investor sentiment is not based on erroneous beliefs disjoint from economic fundamentals, but depends on uncertainty on the fundamentals. Our model can explain sector-specific booms uncorrelated with aggregate economic activity and the overall stock market

[We explore the implications of financial system design for financial innovation. We begin with assumptions about the investment opportunities of firms, their observable attributes, and the roles of commercial banks, investment banks, and the financial market. We examine the borrower's choice between bank and financial market funding, the commercial bank's choice of monitoring capacity, and the investment bank's choice of whether to invest in financial innovation. Our main result is that financial innovation in a universal banking system is stochastically lower than innovation in a financial system in which commercial and investment banks are functionally separated

We analyze the incentives of investment banks to develop innovative products. We show that client characteristics and market structure affect these incentives significantly. Investment banks with larger market shares have greater incentives to innovate and smaller banks are likely to share their innovations with the largest bank. Innovation incentives increase in volatile environments and regulatory scrutiny actually encourages loophole exploitation activity. Our predictions are consistent with stylized facts and the analysis has broad testable implications for innovative activity in other markets similarly characterized by a lack of comprehensive protection for intellectual property rights, for example, the software industry

Firms in younger labor markets produce more innovation. We establish this by instrumenting the current labor force with historical births in each local labor market in the United States. Analyses of firms and inventors allow us to rule out unobservable heterogeneity across local labor markets and firms, life cycles, and other effects. Corporate innovation in younger labor markets reflects the innovative characteristics of younger labor forces, and its market value is higher. Younger workers as a group, not merely inventors by themselves, produce more innovation for firms through the labor force channel rather than through a financing or consumption channel

We analyze the incentives of investment banks to develop innovative products. We show that client characteristics and market structure affect these incentives significantly. Investment banks with larger market shares have greater incentives to innovate and smaller banks are likely to share their innovations with the largest bank. Innovation incentives increase in volatile environments and regulatory scrutiny actually encourages loophole exploitation activity. Our predictions are consistent with stylized facts and the analysis has broad testable implications for innovative activity in other markets similarly characterized by a lack of comprehensive protection for intellectual property rights, for example, the software industry. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies

We study the dynamics of an innovative industry in which agents learn about the likelihood of negative shocks. Managers can exert risk prevention effort to mitigate the consequences of shocks. If no shock occurs, confidence improves, attracting managers to the innovative sector. But, when confidence becomes high, inefficient managers exerting low risk-prevention effort also enter. This stimulates growth, while reducing risk prevention. The longer the boom, the larger the losses if a shock occurs. Although these dynamics arise in the first-best, asymmetric information generates excessive entry of inefficient managers, earning informational rents, inflating the innovative sector, and increasing its vulnerability