The Role of Innovation in Corporate Finance: Empirical Evidence

Abstract

This thesis aims to detect the relationship between innovation and three important topics in corporate finance, including annual report readability, dividend smoothing and corporate payout preference. Innovation, unlike the traditional projects, is intuitively associated with higher risk and lower transparency. However, as the main engine of growth, innovation indicates firms are focusing on the long-run performance and are trying to improve their future prospects. Therefore, information incorporated in innovation can be more complicated than envisioned. To delineate the information and signals conveyed by innovation, our study focuses on three pervasive issues in corporate finance: annual report readability, dividend smoothing, and corporate payout.

Our research starts from the relationship between innovation and annual report readability. We introduce four innovation indicators, namely innovation incentive, innovation intensity, innovation value, and innovation efficiency, with each capturing and reflecting different aspects and the performance involved in innovation activities. We show that less readable annual reports are positively correlated with innovation performance, including innovation incentive, innovation intensity, and innovation value. We also document that firms tend to use unreadable annual reports as substitutes for the accrual-based earnings management, but as the complements for the real earnings management. Thus, the relationship between annual report readability and innovation is more pronounced in firms with aggressive real earnings management, but less accrual earnings management. Introducing the accounting expertise and the product market competition, we also prove that the low readability is an intentional choice, instead of a phenomenon related to the complex business. Overall, our findings provide novel insights that innovation, unlike traditional projects, is able to go along with unreadable and less clear annual reports.

Motivated by the increasingly universal and pervasive dividend smoothing, our second essay addresses whether innovation level is associated with the degree of dividend smoothing. We find that more innovative firms tend to have higher degree of dividend smoothing. This relationship continues to hold after correcting the endogeneity bias, replacing ex-post measures of innovation with the ex-ante R&D intensity and normalizing innovation by industry. We further introduce the financial constraints, finding that instead of encouraging dividend smoothing, financial constraints reduce the degree of dividend smoothing in the innovative companies. Our study also demonstrates that the positive relationship between innovation and dividend smoothing is more pronounced in firms with low cash holdings, while dividend smoothing is especially attractive to those without sufficient cash reserve. Finally, we show that the level of innovation is positively correlated with the degree of dividend smoothing only when firms are covered by few analysts. Overall, this study provides novel empirical evidence on the relationship between innovation and dividend smoothing.

In our third essay, we focus on corporate payout preference, as how firms determine their payout policy is a central topic in corporate finance. We analyze the association between innovation and corporate payout preference, predicting and confirming that firms with more innovation, measured by increasing number of patents and higher patent value, prefer to use share repurchases as their payout methods. This relationship is more pronounced in firms without financial constraints. Other factors, such as temporary cash flows and volatility, can also affect the payout policy in the innovative firms. Our results further prove that internally created innovation, instead of externally purchased technology, can mainly account for the positive correlation between innovation and share repurchases. Overall, the novel nature of our findings provides compelling evidence that innovative firms have a preference for flexible share repurchases over dividends as their payout methods.

Date of Award	18 Jul 2022
Original language	English
Awarding Institution	University of Bath
Supervisor	Dimitrios Gounopoulos (Supervisor) & Winifred Huang (Supervisor)