Hostname: page-component-78c5997874-ndw9j Total loading time: 0 Render date: 2024-11-18T11:51:26.877Z Has data issue: false hasContentIssue false
  • English
  • Français

Innovation Under Ambiguity and Risk

Published online by Cambridge University Press:  27 October 2023

Gabriela Coiculescu ,
Yehuda Izhakian  and
S. Abraham Ravid Open the ORCID record for S. Abraham Ravid [Opens in a new window]
Gabriela Coiculescu
Affiliation:
Yeshiva University Sy Syms School of Business gabriela.coiculescu@yu.edu
Yehuda Izhakian
Affiliation:
Baruch College Zicklin School of Business yehuda.izhakian@baruch.cuny.edu
S. Abraham Ravid*
Affiliation:
Yeshiva University Sy Syms School of Business
*
ravid@yu.edu (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

We view innovation investments as real options and explore the implications of risk (volatility) as well as a newly defined outcome independent measure of ambiguity (Knightian uncertainty) for innovation decisions. The empirical analysis uses stock returns to compute an implementable measure of ambiguity. We also control for risk and other determinants of innovation. We find a consistently significant negative effect of ambiguity on R&D, patents, and citations, as predicted. The effect of risk on R&D is positive and significant, but the corresponding effect on patents and citations is negative and significant. Ambiguity matters more for high-tech firms, consistent with intuition.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 40
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank the two anonymous referees and Jarrad Harford (the editor) for helpful comments and suggestions. We are indebted to Yakov Amihud, Tom Åstebro, Slava Fos, Elad Green, Shu Han, Deepak Hegde, Richard Herron, Joseph Kerstein, Andrey Malenko (discussant), James Ohlson, Joaquin Poblete, Alejandro Rivera, Eduardo Schwartz, Stephen Terry (discussant), Alex Vedrashko, Jaime Zender, and participants at the 2018 Midwest Finance Association Conference, the 2018 Northwestern (Searle Center) Conference on Innovation Economics, the 2019 Knut Wicksell Center Conference on Entrepreneurial Finance, the 2020 European Finance Association Meetings, the 2020 WEFI Seminar, as well as seminar participants at Ben Gurion University, HEC Paris, Hong Kong Poly, Lehigh University, Haifa University, Lund University, New York University, Simon Fraser University, KU Leuven, University of Glasgow, University of Massachusetts, and Yeshiva University, for helpful discussions and comments. Izhakian acknowledges hosting by the Stern School of Business, New York University. The usual disclaimer applies.

References

Abdellaoui, M., and Kemel, E.. “Eliciting Prospect Theory When Consequences Are Measured in Time Units: ‘Time Is Not Money.”’ Management Science, 60 (2013), 1844–1859.CrossRefGoogle Scholar
Abdellaoui, M.; Vossmann, F.; and Weber, M.. “Choice-Based Elicitation and Decomposition of Decision Weights for Gains and Losses under Uncertainty.” Management Science, 51 (2005), 1384–1399.CrossRefGoogle Scholar
Abel, A. B. “Optimal Investment Under Uncertainty.” American Economic Review, 73 (1983), 228.Google Scholar
Aghion, P.; Bloom, N.; Blundell, R.; Griffith, R.; and Howitt, P.. “Competition and Innovation: An Inverted-U Relationship.” Quarterly Journal of Economics, 120 (2005), 70128.Google Scholar
Aghion, P.; Van Reenen, J.; and Zingales, L.. “Innovation and Institutional Ownership.” American Economic Review, 103 (2013), 277–304.CrossRefGoogle Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Anderson, E. W.; Ghysels, E.; and Juergens, J. L.. “The Impact of Risk and Uncertainty on Expected Returns.” Journal of Financial Economics, 94 (2009), 233–263.CrossRefGoogle Scholar
Arellano, M., and Bover, O.. “Another Look at the Instrumental Variable Estimation of Error-Components Models.” Journal of Econometrics, 68 (1995), 29–51.CrossRefGoogle Scholar
Augustin, P., and Izhakian, Y.. “Ambiguity, Volatility, and Credit Risk.” Review of Financial Studies, 33 (2020), 1618–1672.CrossRefGoogle Scholar
Bachmann, R.; Carstensen, K.; Lautenbacher, S.; and Schneider, M.. “Uncertainty Is More Than Risk—Survey Evidence on Knightian and Bayesian Firms.” Working Paper, University of Notre Dame (2020).Google Scholar
Ben-Rephael, A.; Cookson, T.; and Izhakian, Y. “Do I Really Want to Hear the News? Public Information Arrival and Investor Beliefs.” Available at SSRN 3631760 (2022a).CrossRefGoogle Scholar
Ben-Rephael, A.; Cookson, T.; and Izhakian, Y.. “Participation and Trading in Options Markets Under Ambiguity.” Available at SSRN 3628757 (2022b).Google Scholar
Bernstein, S. “Does Going Public Affect Innovation?” Journal of Finance, 70 (2015), 1365403.CrossRefGoogle Scholar
Bernstein, S.; McQuade, T.; and Townsend, R. R.. “Do Household Wealth Shocks Affect Productivity? Evidence from Innovative Workers During the Great Recession.” Journal of Finance, 76 (2021), 57–111.CrossRefGoogle Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–654.CrossRefGoogle Scholar
Bloom, N. “Uncertainty and the Dynamics of R&D.” American Economic Review, 97 (2007), 250–255.CrossRefGoogle Scholar
Bloom, N. “Fluctuations in Uncertainty.” Journal of Economic Perspectives, 28 (2014), 153–176.CrossRefGoogle Scholar
Bloom, N.; Bond, S.; and Van Reenen, J.. “Uncertainty and Investment Dynamics.” Review of Economic Studies, 74 (2007), 391–415.CrossRefGoogle Scholar
Bloom, N.; Davis, S.; Foster, L.; Lucking, B.; Ohlmacher, S.; and Saporta-Eckstein, I.. “Business-Level Expectations and Uncertainty.” Stanford Mimeo (2017).CrossRefGoogle Scholar
Bloom, N.; Schankerman, M.; and Van Reenen, J.. “Technology Spillovers and Product Market Rivalry.” Econometrica, 81 (2013), 1347–1393.Google Scholar
Blundell, R., and Bond, S.. “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models.” Journal of Econometrics, 87 (1998), 115–143.CrossRefGoogle Scholar
Blundell, R.; Griffith, R.; and Van Reenen, J. “Market Share, Market Value and Innovation in a Panel of British Manufacturing Firms.” Review of Economic Studies, 66 (1999), 529–554.CrossRefGoogle Scholar
Brennan, M. J., and Schwartz, E. S.. “Evaluating Natural Resource Investments.” Journal of Business, 58 (1985), 135–157.CrossRefGoogle Scholar
Brenner, M., and Izhakian, Y.. “Asset Prices and Ambiguity: Empirical Evidence.” Journal of Financial Economics, 130 (2018), 503–531.CrossRefGoogle Scholar
Brown, J. R.; Fazzari, S. M.; and Petersen, B. C.. “Financing Innovation and Growth: Cash Flow, External Equity, and the 1990s R&D Boom.” Journal of Finance, 64 (2009), 151–185.CrossRefGoogle Scholar
Bushee, B. “The Influence of Institutional Investors on Myopic R&D Investment Behavior.” Accounting Review, 73 (1998), 305–333.Google Scholar
Cameron, A. C., and Trivedi, P. K.. “Count Panel Data.” In The Oxford Handbook of Panel Data, Baltagi, B. H., ed. Oxford: Oxford University Press (2015), 233–257.CrossRefGoogle Scholar
Chambers, D.; Jennings, R.; and Thompson, R. B.. “Excess Returns to R&D-Intensive Firms.” Review of Accounting Studies, 7 (2002), 133–158.CrossRefGoogle Scholar
Chan, L. K. C.; Josef, L.; and Sougiannis, T.. “The Stock Market Valuation of Research and Development Expenditures.” Journal of Finance, 56 (2001), 2431–2456.CrossRefGoogle Scholar
Chemmanur, T. J.; Kong, L.; Krishnan, K.; and Yu, Q.. “Top Management Human Capital, Inventor Mobility, and Corporate Innovation.” Journal of Financial and Quantitative Analysis, 54 (2019), 2383–2422.CrossRefGoogle Scholar
Chemmanur, T. J., and Tian, X.. “Do Antitakeover Provisions Spur Corporate Innovation? A Regression Discontinuity Analysis.” Journal of Financial and Quantitative Analysis, 53 (2018), 1163–1194.CrossRefGoogle Scholar
Childs, P. D.; Ott, S. H.; and Triantis, A. J.. “Capital Budgeting for Interrelated Projects: A Real Options Approach.” Journal of Financial and Quantitative Analysis, 33 (1998), 305–334.CrossRefGoogle Scholar
Cohen, L., and Lou, D.. “Complicated Firms.” Journal of Financial Economics, 104 (2012), 383–400.CrossRefGoogle Scholar
Crockett, S.; Izhakian, Y.; and Jamison, J.. “Ellsberg’s Hidden Paradox.” Available at SSRN 3423534 (2019).CrossRefGoogle Scholar
Dass, N.; Nanda, V.; and Xiao, S. C.. “Truncation Bias in Patent Data: Implications for Recent Research on Innovation.” Journal of Corporate Finance, 44 (2017), 353–374.CrossRefGoogle Scholar
Dixit, A. K., and Pindyck, R. S.. Investment Under Uncertainty. Princeton, NJ: Princeton University Press (1994).CrossRefGoogle Scholar
Dong, M.; Hirshleifer, D. A.; and Teoh, S. H.. “Misvaluation and Corporate Inventiveness.” Journal of Financial and Quantitative Analysis, 56 (2021), 2605–2633.CrossRefGoogle Scholar
Du, N., and Budescu, D. V.. “The Effects of Imprecise Probabilities and Outcomes in Evaluating Investment Options.” Management Science, 51 (2005), 1791–1803.CrossRefGoogle Scholar
Eberhart, A. C.; Maxwell, W. F.; and Siddique, A. R.. “An Examination of Long-Term Abnormal Stock Returns and Operating Performance Following R&D Increases.” Journal of Finance, 59 (2004), 623–650.CrossRefGoogle Scholar
Ellsberg, D. “Risk, Ambiguity, and the Savage Axioms.” Quarterly Journal of Economics, 75 (1961), 643–669.CrossRefGoogle Scholar
Epstein, L. G., and Schneider, M.. “Learning Under Ambiguity.” Review of Economic Studies, 74 (2007), 1275–1303.CrossRefGoogle Scholar
Gao, H.; Hsu, P.-H.; and Li, K.. “Innovation Strategy of Private Firms.” Journal of Financial and Quantitative Analysis, 53 (2018), 1–32.CrossRefGoogle Scholar
Garlappi, L.; Giammarino, R.; and Lazrak, A.. “Ambiguity and the Corporation: Group Disagreement and Underinvestment.” Journal of Financial Economics, 125 (2017), 417–43.CrossRefGoogle Scholar
Gilboa, I., and Schmeidler, D.. “Maxmin Expected Utility with Non-Unique Prior.” Journal of Mathematical Economics, 18 (1989), 141–153.CrossRefGoogle Scholar
Halevy, Y. “Ellsberg Revisited: An Experimental Study.” Econometrica, 75 (2007), 503–536.CrossRefGoogle Scholar
Hall, B. H.; Jaffe, A. B.; and Trajtenberg, M.. “The NBER Patent Citation Data File: Lessons, Insights and Methodological Tools.” NBER Working Paper No. 8498 (2001).CrossRefGoogle Scholar
Hall, B. H.; Jaffe, A. B.; and Trajtenberg, M.. “Market Value and Patent Citations.” Rand Journal of Economics, 36 (2005), 16–38.Google Scholar
Hartman, R. “The Effects of Price and Cost Uncertainty on Investment.” Journal of Economic Theory, 5 (1972), 258–266.CrossRefGoogle Scholar
Herron, R., and Izhakian, Y.. “Ambiguity, Risk, and Payout Policy.” SSRN eLibrary 2980600 (2017).Google Scholar
Herron, R., and Izhakian, Y.. “Real Investment Under Ambiguity: Evidence from Mergers and Acquisitions.” Available at SSRN 3100611 (2019).Google Scholar
Hoberg, G., and Maksimovic, V.. “Product Life Cycles in Corporate Finance.” Review of Financial Studies, 35 (2022), 4249–4299.CrossRefGoogle Scholar
Hoechle, D.; Schmidt, M.; Walter, I.; and Yermack, D.. “How Much of the Diversification Discount Can be Explained by Poor Corporate Governance?” Journal of Financial Economics, 103 (2012), 41–60.CrossRefGoogle Scholar
Ingersoll, J. J. E., and Ross, S. A.. “Waiting to Invest: Investment and Uncertainty.” Journal of Business, 65 (1992), 1–29.CrossRefGoogle Scholar
Izhakian, Y. “Expected Utility with Uncertain Probabilities Theory.” Journal of Mathematical Economics, 69 (2017), 91–103.CrossRefGoogle Scholar
Izhakian, Y. “A Theoretical Foundation of Ambiguity Measurement.” Journal of Economic Theory, 187 (2020), 105001.CrossRefGoogle Scholar
Izhakian, Y.; Levi, H.; Shalev, R.; and Zur, M.. “The Option to Pay Attention.” Available at SSRN 3489929 (2020).CrossRefGoogle Scholar
Izhakian, Y.; Lewis, R.; and Zender, J.. “Ambiguity and Corporate Yield Spreads.” Available at SSRN 4066052 (2022a).CrossRefGoogle Scholar
Izhakian, Y., and Yermack, D.. “Risk, Ambiguity, and the Exercise of Employee Stock Options.” Journal of Financial Economics, 124 (2017), 65–85.CrossRefGoogle Scholar
Izhakian, Y., Yermack, D., and Zender, J.. “Ambiguity and the Tradeoff Theory of Capital Structure.” Management Science, 68 (2022b), 4090–4111.CrossRefGoogle Scholar
Klibanoff, P.; Marinacci, M.; and Mukerji, S.. “A Smooth Model of Decision Making under Ambiguity.” Econometrica, 73 (2005), 1849–1892.CrossRefGoogle Scholar
Knight, F. M. Risk, Uncertainty and Profit. Boston, MA: Houghton Mifflin (1921).Google Scholar
Kogan, L.; Papanikolaou, D.; Seru, A.; and Stoffman, N.. “Technological Innovation, Resource Allocation, and Growth.” Quarterly Journal of Economics, 132 (2017), 665–712.CrossRefGoogle Scholar
Koh, P.-S., and Reeb, D. M.. “Missing R&D.” Journal of Accounting and Economics, 60 (2015), 73–94.CrossRefGoogle Scholar
Kraft, H.; Schwartz, E.; and Weiss, F.. “Growth Options and Firm Valuation.” European Financial Management, 24 (2018), 209–238.CrossRefGoogle Scholar
Krieger, J.; Li, D.; and Papanikolaou, D.. “Developing Novel Drugs.” Working Paper, Harvard Business School (2017).CrossRefGoogle Scholar
Kumar, P., and Li, D.. “Capital Investment, Innovative Capacity, and Stock Returns.” Journal of Finance, 71 (2016), 2059–2094.CrossRefGoogle Scholar
Kumar, P., and Li, D.. “Innovation, Stock Market Feedback and Good Idiosyncratic Volatility.” Available at SSRN 3160243 (2018).CrossRefGoogle Scholar
Leahy, J., and Whited, T.. “The Effect of Uncertainty on Investment: Some Stylized Facts.” Journal of Money, Credit and Banking, 28 (1996), 64–83.CrossRefGoogle Scholar
Lerner, J.; Sorensen, M.; and Strömberg, P.. “Private Equity and Long-Run Investment: The Case of Innovation.” Journal of Finance, 66 (2011), 44577.CrossRefGoogle Scholar
Lev, B.; Sarath, B.; and Sougiannis, T.. “R&D Reporting Biases and Their Consequences.” Contemporary Accounting Research, 22 (2005), 977–1026.CrossRefGoogle Scholar
Lyandres, E., and Palazzo, B.. “Cash Holdings, Competition, and Innovation.” Journal of Financial and Quantitative Analysis, 51 (2016), 1823–1861.CrossRefGoogle Scholar
Maffioletti, A., and Santoni, M.. “Do Trade Union Leaders Violate Subjective Expected Utility? Some Insights from Experimental Data.” Theory and Decision, 59 (2005), 207–253.CrossRefGoogle Scholar
Malenko, A., and Tsoy, A.. “Optimal Time-Consistent Debt Policies.” Available at SSRN 3588163 (2020).CrossRefGoogle Scholar
Mangelsdorff, L., and Weber, M.. “Testing Choquet Expected Utility.” Journal of Economic Behavior and Organization, 25 (1994), 437–457.CrossRefGoogle Scholar
McDonald, R., and Siegel, D.(1986): “The Value of Waiting to Invest.” Quarterly Journal of Economics, 101 (1994), 707–727.CrossRefGoogle Scholar
Miao, J., and Wang, N.. “Risk, Uncertainty, and Option Exercise.” Journal of Economic Dynamics and Control, 35 (2011), 442–461.CrossRefGoogle Scholar
Peters, R. H., and Taylor, L. A.. “Intangible Capital and the Investment-q Relation.” Journal of Financial Economics, 123 (2017), 251–272.CrossRefGoogle Scholar
Schmeidler, D. “Subjective Probability and Expected Utility Without Additivity.” Econometrica, 57 (1989), 571–587.CrossRefGoogle Scholar
Scholes, M., and Williams, J.. “Estimating Betas from Nonsynchronous Data.” Journal of Financial Economics, 5 (1977), 309–327.CrossRefGoogle Scholar
Schwartz, E. S. “Patents and R&D as Real Options.” Economic Notes, 33 (2004), 23–54.CrossRefGoogle Scholar
Seru, A. “Firm Boundaries Matter: Evidence from Conglomerates and R&D Activity.” Journal of Financial Economics, 111 (2014), 381–405.CrossRefGoogle Scholar
Tirole, J. Industrial Organization. Cambridge, MA: MIT Press (1988).Google Scholar
Trajtenberg, M. “A Penny for Your Quotes: Patent Citations and the Value of Innovations.” RAND Journal of Economics, 21 (1990), 172–187.CrossRefGoogle Scholar
Tversky, A., and Kahneman, D.. “Advances in Prospect Theory: Cumulative Representation of Uncertainty.” Journal of Risk and Uncertainty, 5 (1992), 297–323.CrossRefGoogle Scholar
Viscusi, W. K., and Chesson, H.. “Hopes and Fears: The Conflicting Effects of Risk Ambiguity.” Theory and Decision, 47 (1999), 157–184.CrossRefGoogle Scholar
Wakker, P. P.; Timmermans, D. R. M.; and Machielse, I.. “The Effects of Statistical Information on Risk and Ambiguity Attitudes, and on Rational Insurance Decisions.” Management Science, 53 (2007), 1770–1784.CrossRefGoogle Scholar
Wintoki, M. B.; Linck, J. S.; and Netter, J. M.. “Endogeneity and the Dynamics of Internal Corporate Governance.” Journal of Financial Economics, 105 (2012), 581–606.CrossRefGoogle Scholar
Wu, G., and Gonzalez, R.. “Nonlinear Decision Weights in Choice Under Uncertainty.” Management Science, 45 (1999), 74–85.CrossRefGoogle Scholar
Supplementary material: File

Coiculescu et al. supplementary material

Coiculescu et al. supplementary material
Download Coiculescu et al. supplementary material(File)
File 618.6 KB