[Through the interaction between financial constraints and R&D, I study two asset-pricing puzzles: mixed evidence on the financial constraints—return relation and the positive R&D-return relation. Unlike capital investment, R&D is more inflexible. A financially constrained R&D-intensive firm is more likely to suspend/discontinue R&D projects. Therefore, R&D-intensive firms' risk increases with their financial constraints. Conversely, constrained firms' risk increases with their R&D intensity. I find a robust empirical relation between financial constraints and stock returns, primarily among R&D-intensive firms. Moreover, R&D predicts returns only among financially constrained firms. This evidence suggests that financial constraints potentially drive the positive R&D-return relation.]

Through the interaction between financial constraints and R&D, I study two asset-pricing puzzles: mixed evidence on the financial constraints--return relation and the positive R&D-return relation. Unlike capital investment, R&D is more inflexible. A financially constrained R&D-intensive firm is more likely to suspend/discontinue R&D projects. Therefore, R&D-intensive firms' risk increases with their financial constraints. Conversely, constrained firms' risk increases with their R&D intensity. I find a robust empirical relation between financial constraints and stock returns, primarily among R&D-intensive firms. Moreover, R&D predicts returns only among financially constrained firms. This evidence suggests that financial constraints potentially drive the positive R&D-return relation. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

We study the dynamic implications of capital investment in innovative capacity (IC) on future stock returns, investment, and profitability by modeling the unique effects of IC investment on uncertain option generation/exercise and postexercise revenue. The model highlights the diverse effects of IC investment on expected returns in different postinvestment regimes and yields the novel prediction that, under the neoclassical assumption of nonincreasing revenue returns, IC investment is positively related to subsequent cumulative stock returns with a lag. The model also predicts a positive effect of IC investment on future investment and profitability. We find strong empirical support for these predictions.

We find that innovative efficiency (IE), patents or citations scaled by research and development expenditures, is a strong positive predictor of future returns after controlling for firm characteristics and risk. The IE-return relation is associated with the loading on a mispricing factor, and the high Sharpe ratio of the Efficient Minus Inefficient (EMI) portfolio suggests that mispricing plays an important role. Further tests based upon attention and uncertainty proxies suggest that limited attention contributes to the effect. The high weight of the EMI portfolio return in the tangency portfolio suggests that IE captures incremental pricing effects relative to well-known factors.

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.

Firms can become less innovative following a sudden cash “inflow.” Specifically, multinational firms that were eligible to repatriate (and indeed repatriated) cash to the United States under the American Jobs Creation Act (AJCA) generate less valuable patents than otherwise similar firms. They also explore more. This effect only exists among firms in less competitive industries, firms with lower institutional ownership (IO), and firms with overconfident chief executive officers (CEOs); this effect is mainly driven by the reduction in the value of U.S.-originated patents. Our evidence suggests that, without appropriate governance, a cash windfall may lead managers to engage in riskier innovation strategy, which can destroy value.

We analyze the effects of limited investor attention on the stock market reaction to innovation announcements and develop a new measure of patents’ economic value. We hypothesize that, when some investors pay delayed attention to innovation announcements, there will be a post-announcement drift in addition to the announcement effect, with the former decreasing and the latter increasing in investor attention. Using media coverage and abnormal Google search volume as investor attention proxies, we find consistent evidence. Our new attention-weighted measure of patents’ economic value has greater predictive power for future firm performance than measures based on the announcement effect alone.