CEOs' market sentiment and corporate innovation: The role of financial uncertainty, competition and capital intensity

Abstract

Using panel data of 2225 firms headquartered in the US, we examine the effects of CEOs' market sentiment on corporate innovation capacity. We also examine the extent to which sentiment-innovation relation is moderated by: (i) financial uncertainty/vulnerability; (ii) competition; (iii) firm size and growth prospects; (iv) capital intensity; and (v) operational complexity. The results indicate that, both across and within firms, innovation declines when CEOs perceive market conditions to be good (high sentiment periods). In addition, the negative sentiment-innovation relation observed during high sentiment periods is enhanced when firms are large, and have high growth prospects and greater operational complexities. Nevertheless, firm innovation increases significantly during high sentiment periods when firms anticipate uncertainties about future cash flows, when competition is intense, and when capital intensity creates extreme entry barriers. Our core explanations hold even after accounting for endogeneity and using alternative measures of firm innovation.