Corporate Governance and Innovation under Demand Uncertainty: A Panel Study of Korean Firms

Abstract

Existing literature has identified the effects of competition and firms’ ownership and management structure on firms’ decisions to invest in innovation. We extend this literature by examining the role of market-demand uncertainty on the relationship between firm ownership, management structure and management turnover, on the one hand, and firms’ innovation on the other hand. We evaluate the effects of firms’ competitiveness, concentration of firms’ ownership, presence of foreigners among owners and on owner-appointed corporate boards of directors, management independence, and management turnover rates on firms’ patent applications under varying degrees of demand uncertainty. The validity of alternative hypotheses about management motivation - lazy manager, career concerns, prospect theory, and special East-Asian institutional constraints hypotheses - is evaluated, controlling for firms’ prior investment in innovation and firm characteristics. Unique data for 711 Korean firms and nine years, 2003-2011, are used (4,339 records). We find support for the lazy-manager hypothesis by identifying substitutability between competitive pressures and owner-manager separation in driving managers’ effort to pursue innovation. Demand uncertainty raises managers’ incentives to innovate, by increasing the potential stake from innovation and increasing the risk of default if firms fail to innovate. There is little evidence that Korean managers pursue innovation to ease their career concerns or to meet an expected performance yardstick, or that they follow an idiosyncratic East-Asian pattern. Management turnover has little effect on innovation, and firms’ existing performance increases innovation. Foreign ownership and direction, and the share of the largest firm owner have little effect on firms’ innovation.