Helping Hand or Punching Fist？ How Stock Liquidity Affects Corporate Innovation in China
LIN Zhifan, DU Jinmin, LONG Xiaoxuan
Institute of Advanced Studies in Humanities and Social Sciences, Beijing Normal University; School of Economics, Jinan University; Strategic Development Center, Zhuhai Huafa Group Co, Ltd
Summary:
Innovation is crucial to economic development and provides strategic support for the construction of a modern economic system. The capital market plays a key role in promoting corporate innovation and driving economic growth. The Chinese stock market has been developing for nearly 30 years. Market liquidity is increasing with the vigorous development of a multi-level capital market. In this context, this paper explores how stock liquidity affects the innovation strategies of listed companies. The theoretical literature observes that stock liquidity may have two opposing effects on enterprise innovation. One stream of the literature asserts that stock liquidity stimulates corporate innovation because higher stock liquidity lowers the transaction cost of voting with one's feet. This lower transaction cost is conducive to the entry and exit of large shareholders and institutional investors. Such shareholders and investors are usually active in collecting private information and monitoring managers and thus effective in alleviating the principal-agent problem. Managers therefore pay more attention to corporate governance and devote more resources to R&D activities that enhance company value. This account can be termed the “incentivizing mechanism” of stock liquidity on innovation. Another stream of literature points out that stock liquidity may instead inhibit corporate innovation. This can be termed the “pressure mechanism”. The inhibition of innovation occurs for several reasons. First, the volatility of stock prices caused by large-scale trading is smaller with higher liquidity. This makes it easier for malicious buyers to cover up large purchases in the secondary market. Managers need to spend more time and energy monitoring stock market transactions when facing such threats. Second, managers need to boost financial performance and maintain high stock prices to raise the costs of malicious purchases. This often requires the reduction of R&D activities. Finally, higher stock liquidity may attract more short-term speculators and passive institutional investors who neither care about corporate fundamentals nor have the incentive to supervise managerial decision-making. This effect often leads to myopic managerial behavior, which may also reduce innovation. These theoretical controversies suggest that the problem of how stock liquidity affects innovation is essentially empirical. It is worth noting that the Chinese government has made innovation a national policy in recent years and the capital market pays special attention to the innovativeness of listed companies. Under capital market pressure, companies may resort to increasing marginal invention applications and filing many utility models and design patents so that they may appear to have good development prospects. Our findings are as follows, empirically based on detailed patent data from Chinese listed companies. First, higher stock liquidity leads to significantly more invention applications but does not lead to more grants that are able to pass substantial review. This signals a decline in application quality. Second, higher stock liquidity leads to a significant increase in low quality utility models and designs in the Chinese patent system. These low-quality patents are shown to have negative effects on profitability, and companies less willing to maintain their legal validity. This finding implies that companies only innovate strategically under capital market pressure. Sub-sample regressions reveal that strategic patenting is particularly pronounced among non-state-owned companies, companies in traditional industries, and companies with low long-term institutional investor holdings. We do not advocate suppressing market liquidity as a solution to the patent bubble problem. Market supervisors should instead persuade investors to base their investment decisions on listed companies' substantive innovative capabilities so that irrational speculative trading can be reduced. The government could also gradually introduce investors with long-term investment visions and value orientations into the capital market, such as social security pension funds. This would help to stabilize entrepreneurs' expectations and encourage innovation.
林志帆, 杜金岷, 龙晓旋. 股票流动性与中国企业创新策略:流水不腐还是洪水猛兽？[J]. 金融研究, 2021, 489(3): 188-206.
LIN Zhifan, DU Jinmin, LONG Xiaoxuan. Helping Hand or Punching Fist？ How Stock Liquidity Affects Corporate Innovation in China. Journal of Financial Research, 2021, 489(3): 188-206.
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