Topic: Good ratings but bad innovation: An unintended consequence of enhanced market perceptions

Speaker: Xuan Tian, Professor of Finance, PBC School of Finance, Tsinghua University

Date: October 8th, 2014 (Wed.)

Time: 12:10-1:10pm

Location: Building 1, Room 501, Faculty Lounge

Language: English

Abstract:

This paper examines how market perceptions, as opposed to actual changes, of a firm’s credit quality affect its innovation activities. Exploiting Moody’s 1982 credit rating refinement that is not related to a firm’s fundamental credit risk but exogenously changes the market’s perceptions of a firm’s credit quality, we find that firms with improved market perceptions produce fewer patents and lower quality patents. We explore two plausible underlying mechanisms to explain this finding. First, enhanced market perceptions expose a firm to elevated analyst earnings forecasts, pressing the firm to lower its innovation investment to beat the heightened earnings targets from analysts. Second, enhanced market perceptions of a firm’s credit quality attract a large number of major customers and generate rising production demands for the firm to fulfill in the short run, diluting the firm’s long-term innovation investments. Our paper therefore highlights an unintended, yet less well understood consequence of an enhanced market perception – its hindrance on firms’ investment in innovation.