New Entry Threats, Corporate Governance, and Innovation in the U.S. IT Industry

Abstract

We examine how firms in the IT industry adjust their innovation strategy as a response to the potential entry threats they face in their product markets. While turbulence in the product markets caused by startups affects an incumbent firm’s investment decisions, prior research has provided contrasting theoretical predictions on the relationship between new entry threats and innovation strategy. In addition, the absence of acceptable industry classifications for startups, as well as the inability to accurately gauge when they represent a credible threat has limited empirical research into this question. In this paper, we first contribute a new measure of identifying these threats through text analyses based on product descriptions provided by incumbent firm 10-K filings and business descriptions provided by start-ups. This new measure differs significantly from approaches that use static industry classifications, which are backward-looking and do not fully account for industry evolution over time. We show the text-based measure captures entry threats from the startup space through a series of validation tests. Second, using a sample of U.S. IT firms over the period 1997-2013, we show that incumbent firms react to new entry threats by systematically reducing innovation investments. We show these effects to be robust to a series of regression specifications addressing the endogeneity of new entry threats. Interestingly, we also find that in the face of intensive new entry threats, firms with diversified product portfolios are less aggressive in terms of reducing their innovation spending, compared to specialized firms. We discuss the research and practice implications of the new text-based measure for new entry threats as well as the responses to these threats by incumbents in the paper.