Summary:
In the context of intensifying global innovation competition, China is undergoing a pivotal shift from quantity-led to quality-driven innovation. Despite topping global rankings in metrics such as patent counts and R&D spending, the persistent lag in innovation quality remains a structural bottleneck to achieve high-quality economic growth. While existing research has highlighted the decisive role of capital market pricing efficiency in allocating innovation resources, prior studies have largely centered on market premiums associated with innovation inputs (e.g., R&D investment) or output volumes (e.g., patent applications), overlooking the pricing mechanism of innovation quality, a key dimension. Based on the special situation of China's capital market, this study systematically examines the existence and formation mechanism of innovation quality premium. By constructing a novel composite innovation quality index—integrating patent citation network metrics with advanced text mining techniques—we identify a significant and distinct premium associated with innovation quality, which is different from the innovation input premium and output quantity premium. This premium is economically meaningful and statistically robust, remaining consistent after changing the index construction method, replacing the time interval and controlling the potential influencing variables. Mechanism analysis reveals that conventional explanations—such as market frictions or investor behavioral biases—fail to explain the observed premium. Instead, our findings point to investor-required risk compensation for high risk exposure as the primary driver. This risk exposure arises from the dual characteristics of growth options embedded in high-quality innovation. While such innovation enhances long-term firm value, it simultaneously elevates operational volatility and project discontinuation risks, which ultimately transmit through capital markets into firms' systematic and higher-moment statistical risks. Heterogeneity analyses further reveal: (1) The U.S.-China trade war significantly intensified innovation-related risk exposure, particularly for tech-intensive firms; and (2) private enterprises are more sensitive to innovation risks than their state-owned counterparts. Distinct from the U.S. market, China's innovation premium reflects a unique interplay between the high-risk nature of innovation and the capital market's pronounced risk aversion—a pattern shaped by two structural constraints: short investment horizons and underdeveloped risk-hedging mechanisms. To address these challenges and promote quality-driven innovation, we propose a three-pronged policy framework: (1) Establishing a capital market evaluation system centered on innovation quality to improve market recognition and pricing of substantive technological breakthroughs; (2) Developing mechanisms to cultivate long-term capital and optimizing the structure of capital supply, including tax incentives and investment mandates for institutional investors, to counteract corporate myopia; and (3) Implementing more inclusive market mechanisms—such as differentiated listing standards and mechanisms for tolerating failure in innovation—to reduce trial-and-error costs and encourage risk-taking in R&D. Collectively, these policies aim to dismantle systemic barriers to quality-based innovation and mitigate excessive market risk aversion. This study makes three key contributions to the literature. First, this study breaks through the limitations of existing research on innovation quantity dimensions by systematically revealing the pricing effects of quality dimensions for the first time. Second, it identifies significant differences in the formation mechanisms of innovation premiums between Chinese and the U.S. markets. The inherent high-risk nature of innovative activities and market participants' strong risk-averse tendencies jointly establish the dominance of risk compensation mechanisms. Third, it proposes an institutional innovation pathway to transform risk premiums from “market phenomena” into “policy tools”. Together, these insights provide a novel framework for addressing China's persistent “quantity-quality paradox” in innovation-led development.
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