Abstract
We find that firms facing high innovation competition earn significantly higher stock returns, even after controlling for common return determinants such as firm size, book-to-market equity ratio, momentum, leverage, firm-level R&D and patent activities. The result holds with different measures of innovation competition. More importantly, the innovation competition premium is distinct from and even subsumes the effects of product market competition documented earlier in the literature. We posit that the premium arises to offset the additional risks from the uncertainty in cash flows and the deterioration in the firms’ assets in place resulting from the more intense technology competition. Our empirical results on the level of riskiness and additional time-series tests strongly support the hypothesis. Overall, the current evidence suggests that the level of innovation competition is an important risk factor.
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