Innovation, Future Earnings, and Market Efficiency

This study examines whether patent citation impact, a leading indicator of technology firms' innovation capabilities, is associated with future earnings and whether this association is appropriately reflected in stock prices and analysts' earnings forecasts of patent-rich companies. The results indicate that change of patent citation impact is positively associated with future earnings, particularly in industries with relatively short time lags between technological advances and profit realization (e.g., computers, electronics, and medical equipment). The strength of this relation also significantly increases with time for up to five years in the future. Market participants, including investors and analysts, however, do not fully incorporate the implication of enhanced innovation capabilities for future earnings into stock prices and earnings forecasts. This bias is significantly associated with future abnormal stock returns.

[1]  S. Mann,et al.  Innovation and Intellectual Property Protection in the Software Industry: An Emerging Role for Patents? , 2004 .

[2]  Peter Easton,et al.  EARNINGS AS AN EXPLANATORY VARIABLE FOR RETURNS , 1991 .

[3]  James A. Ohlson,et al.  Book Rate-Of-Return And Prediction Of Earnings Changes - An Empirical-Investigation , 1982 .

[4]  Douglas J. Skinner,et al.  Recommendations on Disclosure of Nonfinancial Performance Measures , 2002 .

[5]  Mark H. Lang,et al.  Corporate Disclosure Policy and Analyst Behavior , 1998 .

[6]  P. Elgers,et al.  Reductions In Analysts Annual Earnings Forecast Errors Using Information In Prior Earnings And Security Returns , 1994 .

[7]  B. Lev,et al.  The capitalization, amortization, and value-relevance of R&D , 1996 .

[8]  Shivaram Rajgopal,et al.  Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future Earnings? Evidence from Order Backlog , 2001 .

[9]  Paul Stoneman,et al.  Handbook of the economics of innovation and technological change , 1995 .

[10]  Robert A. Peterson,et al.  First-Mover Advantage: A Synthesis, Conceptual Framework, and Research Propositions , 1992 .

[11]  E. Fama,et al.  Risk, Return, and Equilibrium: Empirical Tests , 1973, Journal of Political Economy.

[12]  B. Lev.  Intangibles: Management, Measurement, and Reporting , 2001 .

[13]  Mark A. Schankerman,et al.  Characteristics of patent litigation: a window on competition , 2001 .

[14]  Shivaram Rajgopal,et al.  Why is the Accrual Anomaly Not Arbitraged Away? , 2004 .

[15]  F. T. Magiera.  Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings , 1997 .

[16]  R. Banker,et al.  An Empirical Investigation of an Incentive Plan that Includes Nonfinancial Performance Measures , 2000 .

[17]  Brett Trueman,et al.  The Eyeballs Have it: Searching for the Value in Internet Stocks , 2000 .

[18]  Frederic S. Mishkin,et al.  A Rational Expectations Approach to Macroeconometrics: Testing Policy Ineffectiveness and Efficient-Markets Models. , 1984 .

[19]  Manuel Trajtenberg,et al.  The Welfare Analysis of Product Innovations, with an Application to Computed Tomography Scanners , 1989, Journal of Political Economy.

[20]  B. Lev,et al.  The Information Content of Royalty Income , 2004 .

[21]  M. Kuhn,et al.  An empirical investigation of self-attitudes. , 1954 .

[22]  B. Lev,et al.  Value-Relevance of Nonfinancial Information: The Wireless Communications Industry , 1996 .

[23]  Wayne S. Upton.  Business and financial reporting, challenges from the new economy , 2001 .

[24]  Dale A. Stirling,et al.  Information rules , 2003, SGMD.

[25]  Timothy F. Bresnahan,et al.  Post-Entry Competition in the Plain Paper Copier Market : American Economic Review , 1985 .

[26]  Manuel Trajtenberg,et al.  Market Value and Patent Citations: A First Look , 2000 .

[27]  Carl Shapiro,et al.  Patent Licensing and R&D Rivalry , 1985 .

[28]  F. Narin,et al.  Science and Technology as Predictors of Stock Performance , 1999 .

[29]  Aswath Damodaran,et al.  The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies , 2001 .

[30]  Hong Xie.  THE MISPRICING OF ABNORMAL ACCRUALS , 2001 .

[31]  V. Bernard,et al.  Evidence that stock prices do not fully reflect the implications of current earnings for future earnings , 1990 .

[32]  W. Beaver.  The Time Series Behavior of Earnings , 1970 .

[33]  D. Larcker,et al.  Innovations in Performance Measurement: Trends and Research Implications , 1998 .

[34]  Victor L. Bernard,et al.  Tests of Analysts' Overreaction/Underreaction to Earnings Information as an Explanation for Anomalous Stock Price Behavior , 1992 .

[35]  G. Arncliffe Percival.  The electric lamp industry , .

[36]  Dietmar Harhoff,et al.  Uncertainty and the size distribution of rewards from innovation , 2000 .

[37]  M. Trajtenberg.  A Penny for Your Quotes : Patent Citations and the Value of Innovations , 1990 .

[38]  W. Rl.  New drug approvals in 1998. , 1999 .

[39]  Richard G. Sloan,et al.  Do Analysts and Auditors Use Information in Accruals , 2001 .

[40]  B. Lev,et al.  Do financial analysts get intangibles? , 2003 .

[41]  M. Spence.  Cost Reduction, Competition and Industry Performance , 1984 .

[42]  W. T. Bush,et al.  The Intangibles of Management , 1980 .

[43]  Richard G. Sloan.  Do Stock Prices Fully Reflect Information in Accruals and Cash Flows About Future Earnings , 1998 .

[44]  Zvi Griliches,et al.  R&D, Patents, and Productivity , 1981 .

[45]  Terence Lim,et al.  Rationality and Analysts' Forecast Bias , 2001 .

[46]  Zvi Griliches,et al.  R&D, Patents, and Market Value Revisited: is There Evidence of a Secondtechnological Opportunity Related Factor? , 1988 .

[47]  Josef Lakonishok,et al.  The Stock Market Valuation of Research and Development Expenditures , 1999 .

[48]  D. Larcker,et al.  Are nonfinancial measures leading indicators of financial performance? An analysis of customer satisfaction , 1998 .

[49]  Zvi Griliches,et al.  R&D, Patents, and Market Value Revisited: is There Evidence of a Secondtechnological Opportunity Related Factor? , 1988, Economics of Innovation and New Technology.

[50]  Sudipta Basu,et al.  Loss Firms and Analysts' Earnings Forecast Errors , 1996 .

[51]  P. Romer.  Endogenous Technological Change , 1989, Journal of Political Economy.

[52]  M. Paul,et al.  ENDOGENOUS TECHNICAL CHANGE , 1990 .

[53]  L. Brown.  A Temporal Analysis of Earnings Surprises: Profits Versus Losses , 2001 .

[54]  Richard A. Riley,et al.  Using Nonfinancial Information to Predict Financial Performance: The Case of the U.S. Airline Industry , 1999 .

[55]  Suresh Kotha,et al.  The Value-Relevance of Network Advantages: The Case of E-Commerce Firms , 2003 .