"Enemies at the Gate? Product Market Threats, Firm Governance, and Innovation in the High-Tech Sect"

Abstract

In this work we examine how a firm’s innovation output is shaped by two factors that have been under-studied in the literature: 1) the potential threats the firm faces in its product market, and 2) the firm’s governance structure. We argue that: 1) product market threats, i.e., turbulence in the product markets caused by an incumbent firm’s competitors and new entry threat from entrepreneurial startups, affect the focal firm’s investments in long-term risky activities such as innovation, and 2) this relationship is moderated by the extent to which senior management within the firm is protected through corporate governance. We differentiate product market threats from measures of product market competition, which are backward-looking and do not fully account for industry evolution over time. In addition, these measures fail to capture competition from start-ups. In order to address these issues, we create two new measures of product market threats from incumbents and start-ups separately based on text analyses of product descriptions. We measure governance using the G- Index (Gompers et al. 2003). Our analyses, performed on a sample of U.S. high-tech firms during the period 1997-2007, show that firms react to the product market threats, from both established firms and from entrepreneurs, by reducing innovation. Moreover, more governance provisions protecting managers contribute positively to innovation, confirming the hypothesis of long-term value creation. However, evidence also suggests that such protection is less effective when a firm is under competitive pressure: the positive effect of protected managers on promoting innovation is weaker when the firm faces intensive product market threats, especially those from entrepreneurial ventures. We discuss the implications for research and practice.