Economics, Education, Finance, Governance

Management quality and innovation

It is well recognized that innovation is an important ingredient in generating the competitive advantage and long-run growth of nations, ultimately affecting their economic development. Thus, there is considerable interest in the determinants of innovation, not only in the corporate sector but also among policy makers around the world and in Asia in particular. Several recent studies indicate that one important aspect of firms that may significantly affect their ability to achieve high-quality innovation outcomes is the human capital or “quality” of their top management teams. Higher quality management teams tend to hire better scientists and other researchers, invest in more innovative projects, and manage these projects more ably, leading to higher innovation productivity. Given the importance of management quality in affecting corporate innovation, venture capitalists and other early-stage investors analyze the top management quality of private firms before investing. Provided that small private firms undertake a significant fraction of cutting-edge innovation, this underscores the importance of top management quality as a determinant of corporate innovation.

A recent study by Chemmanur, Gupta, and Simonyan (2016) shows that private firms (prior to going public) with higher quality top management teams have significantly higher innovation productivity as measured by a greater amount of research and development (R&D) expenses, a greater number of patents, and more citations per patent. Higher innovation productivity, coupled with higher management quality, is rewarded later in the initial public offering (IPO) market when such firms eventually go public as they receive significantly higher valuations both in the IPO market and in the immediate secondary market, are able to go public at a younger age, and realize significant growth in post-IPO operating performance.

Management quality is an important determinant of corporate innovation, not only in early-stage firms but also in seasoned firms as indicated by another recent study by Chemmanur et al. (2015). Seasoned firms with higher quality top management teams invest more in R&D and generate more patents and citations per patent. They are able to do so by hiring a greater number of higher quality innovators and engaging in both exploratory and exploitative innovation strategies. Exploratory innovation strategies are those that are very risky and result in either highly successful or failed innovations, while exploitative innovation strategies are those that employ more conventional technologies in areas that are more familiar to the firm.

The quality of a firm’s top management team may also affect its ability to innovate indirectly by affecting various aspects of the firm’s corporate governance, such as the extent of its anti-takeover protection. The latest academic research (Chemmanur and Jiao 2012) argues that anti-takeover defenses may be valuable in the hands of higher quality managers by insulating them from the pressures arising in the market for corporate control and allowing them to implement valuable long-term investment projects (which are likely to be highly innovative). The empirical evidence tends to confirm this argument in various contexts: for example, among a sample of IPO firms that went public during 1993–2001, those with higher top management team quality had a greater number of anti-takeover provisions in their corporate charters at the time of going public (Chemmanur, Paeglis, and Simonyan 2011); and established firms with a greater number of anti-takeover provisions generated greater innovation productivity (Chemmanur and Tian 2016).

The venture capital backing of entrepreneurial firms is another important driver of corporate innovation, and it affects innovation both directly and indirectly by increasing management quality. Indeed, firms that are backed by venture capital have higher top management team quality at the time of going public compared to firms that are not backed by venture capital (Chemmanur, Simonyan, and Tehranian 2016).

The management quality of an entrepreneurial firm may affect its ability to innovate by also influencing its decision to go public, to be acquired, or to stay private. However, the evidence suggests that the effect of management quality on corporate innovation through the timing of the decision to go public is complex: on the one hand, firms with higher quality management teams are able to go public at a younger age (Chemmanur, Simonyan, and Tehranian 2016), but on the other hand, whether it is optimal for them to do so depends on the nature of the innovative activities undertaken by the firm.

While the existing evidence on the effect of management quality on corporate innovation is based largely on United States (US) firms, this evidence can be generalized to firms all over the world given the fact that the relationship between management quality and innovation holds for firms in a variety of different US contexts, such as for private and public firms, firms that have recently gone public and seasoned firms, and venture-backed and non-venture-backed firms. Thus, one would expect the positive relationship between management quality and innovation to hold for Asian firms as well. In light of this, the governments of Asian countries can foster corporate innovation by implementing several policies.

  1. Given the large untapped human capital resources of Asian countries, it makes sense for governments to invest not only in developing technical and scientific education and improving the technical skills of employees directly involved in innovative activities (such as preparing high-quality scientists and researchers) but also to invest in developing management education and training so as to increase the managerial skills and human capital of the managers of various firms. This is because in order to increase innovation productivity, it is important that innovative resources be managed well.
  2. Firms, especially those in high technology and other innovative industries, should be allowed to have anti-takeover provisions in their corporate charters. Corporate and business laws and stock exchange listing requirements should not discourage the use of dual-class share structures, staggered boards, or other firm-level anti-takeover provisions since these lengthen corporate investment horizons and foster corporate innovation.
  3. Encouraging the growth of local venture capital industries in various Asian countries may pay rich dividends by enhancing the inputs into innovation and the productivity of corporate innovation. In addition to encouraging the development of local venture capital industries, encouraging the participation of highly reputable foreign venture capitalists may also be conducive to enhancing innovation in Asian countries.
  4. Reducing regulatory and other barriers and the monitoring costs involved in the process of going public in Asian countries is likely to allow firms to choose optimally between private and public status depending upon the nature and stage of their innovation activities, thereby enhancing corporate innovation in these countries. Asian and other developing countries need to develop their IPO and other equity markets to the greatest extent possible since in many highly innovative industries, firms require large infusions of capital in their early years while hardly yielding any profits: getting efficient access to the IPO market when the firms are very young is the cheapest way for them to raise the capital required.

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References:

Chemmanur, T. J., M. Gupta, M., and K. Simonyan. 2016. Management Quality and Innovation in Private Firms and the IPO Market Rewards to Innovative Activity. Boston College, Nottingham University, and Suffolk University Working Paper.
Chemmanur, T. J., and Y. Jiao. 2012. Dual-Class IPOs: A Theoretical Analysis. Journal of Banking and Finance 36(1): 305–319.
Chemmanur, T. J., L. Kong, K. Krishnan, and Q. Yu. 2015. Top Management Human Capital, Inventor Mobility, and Corporate Innovation. Boston College and Northeastern University Working Paper.
Chemmanur, T. J., I. Paeglis, and K. Simonyan. 2011. Management Quality and Antitakeover Provisions. Journal of Law and Economics 54(3): 651–692.
Chemmanur, T. J., K. Simonyan, and H. Tehranian. 2016. The Effect of Venture Capital Backing on Top Management Quality and Implications for Initial Public Offerings. Boston College and Suffolk University Working Paper.
Chemmanur, T. J., and X. Tian. 2016. Do Anti-Takeover Provision Spur Corporate Innovation? Journal of Financial and Quantitative Analysis, forthcoming.

Photo: By geralt (“Office Business Businessmen Shaking Hands Handshake“). Licensed under CC0 1.0 Universal (CC0 1.0)

Thomas J. Chemmanur

About the Author

Thomas J. Chemmanur is professor of finance and Hillenbrand Distinguished Fellow, Carroll School of Management, Boston College.

Karen Simonyan

About the Author

Karen Simonyan is associate professor of finance, Sawyer Business School, Suffolk University.

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