SELECTION: Co-Evolution of Industry Dynamics and Financial Dynamics


The stock market's valuation of innovative vs. non-innovative firms affects resource allocation in the economy, and therefore represents a key transmission mechanism from finance to the real economy. Work Package 2 will focus on this interplay between firm level innovation and financial performance.

The research will extend existing work on finance and innovation by exploring which types of firm level characteristics are essential catalysts for achieving better stock-market valuation via innovation. Traditionally the literature has shown that firm level innovation (measured by firm's stocks of R&D and patents) positively affects market value. However, recent work from members of this work package, has shown that the relationship between R&D and firm growth is far from clear (Demirel and Mazzucato 2008). Firms that invest in innovation do not always grow more than non-innovative firms. Only firms with certain types of characteristics benefit from their innovative efforts. To what degree is this also true for financial performance? That is, are the firm level characteristics needed for innovation to translate into growth the same as those needed for innovation to translate into higher market value? How does this differ between sectors and periods in the 'industry life-cycle'?

Policy relevance: Targets to increase R&D intensity to 3% in the EU is a core part of the EC's Lisbon Agenda (2005) which aims to achieve innovation led growth across Europe. Results from this research will allow EC innovation policy to better understand which firm level characteristics must be in place for R&D (and other proxies for innovation) to have a positive effect on growth and financial market performance, and how such relationships differ across sectors.

Description of work

Effect of innovation on financial performance
Work Package 2 will investigate the effect of innovation on financial performance. It will ask:

  1. Which firm-specific characteristics determine the strength of the relationship between innovation and different measures of economic and financial performance (e.g. profits, growth, stock prices, market value).
  2. How do these firm-specific characteristics differ in different sectors and different periods of the industry life-cycle?
  3. Do the characteristics of the innovation (e.g. general vs. original) affect this relationship?
  4. What insights do the answers to these questions provide on the strength and character of market selection, and the ways that selection processes differ in industrial markets (impact on growth) and financial markets (impact on market value)?

Work Package leader: Mariana Mazzucato, The Open University