Alumni Changing the World

Jan Bena: “Strategic Investments, Technological Uncertainty, and Expected Return Externalities”

Room 3, 2nd floor

Abstract:

We study the effect of competition in technological innovation on asset prices. Using a model of an innovation race in which firms face both technological and market-wide uncertainty when they exercise innovation options, we show that a firm's investment in innovation imposes an expected return "externality" on its rivals. In equilibrium, a firm's expected return decreases when the firm invests, but it increases when the rivals invest. Furthermore, the model predicts that a firm's expected return increases as the firm falls behind in the race. We test this cross-sectional prediction using an economy-wide panel on patenting activity of firms in the U.S. from 1976 to 2006 and find that the prediction is strongly supported in the data. Our analysis suggests that strategic considerations in investments are an important underpinning of the cross-section of returns.