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Working Paper

Do Innovations Really Pay Off? Total Stock Market Returns to Innovation

Ashish Sood and Gerard J. Tellis, 2008 [08-106]

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Critics often decry an earnings-focused short-term orientation of management that eschews spending on risky, long-term projects such as innovation in order to boost a firm’s stock price. The critics assume that stock markets respond to announcements of earnings that report immediate earnings and not to announcements of innovations that have a long-term payoff. Contrary to this position, in the current study, Ashish Sood and Gerard Tellis argue that the stock markets react positively to innovation. However, the market’s true appreciation of innovation can be estimated only by assessing the total market returns to the entire innovation project via event analysis. In the past, researchers computed market returns to only isolated innovation events, rather than the entire innovation project, as demonstrated in the current study.

The authors demonstrate this approach via the Fama-French Momentum four-factor model (FFM) on 5,481 announcements from 69 firms in 5 categories and 19 technologies, during the period 1977–2006. Markets do respond promptly and substantially to announcements about innovation at all stages of the innovation project. For the innovation initiatives they study, total market returns to an innovation project are, on average, $643 million—more than 13 times the $49 million that has typically been found to accrue to an average innovation event.

In addition, the absolute value of a negative announcement is greater than that of a positive announcement. Thus, firms should be cautious not to exaggerate progress in their innovation projects or to resort to vaporware.

The authors divide innovation projects into three types of activity: setup, development, and market activities. Of these, returns to development activities are higher than returns to either setup or market activities. Thus, it is important that firms exploit progress in development by fully announcing all development-related events.

Their findings on various announcement strategies indicate that a mere increase or decrease in either the frequency or total number of announcements does not lead to an increase or decrease in returns. Moreover, the first announcement of a project is no more important than later announcements.

About the authors
Ashish Sood is Assistant Professor of Marketing, Goizueta School of Business, Emory University. Gerard J. Tellis is Professor of Marketing, Director of the Center for Global Innovation, and Neely Chair in American Enterprise at the Marshall School of Business, University of Southern California.

Included in the following collections:
Executive Director's Letter 08-002
MSI Reports 2008

A New Look at Returns on Investments in Innovation
2008  [08-insfd]
This study finds that markets respond promptly and substantially to innovation announcements.

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