The Interaction Effect of Text-Based Corporate Innovation and Economic Policy Uncertainty on Firm Performance

Abstract

Prior research shows that corporate innovation enhances firm value. Using a novel text-based measure of corporate innovation, we explore how the effects of corporate innovation on firm performance change in the presence of economic policy uncertainty. We use a large sample of US firms over the period 1996 to 2010 to test the relationship by executing firm-fixed effect regressions. Our results show that corporate innovation significantly positively affects firm performance. However, our results also reveal that the favorable effect of corporate innovation on firm value is reduced substantially in times of greater economic policy uncertainty. The latter result highlights the urgent need for policymakers to maintain the long-term consistency of economic policies to encourage firms’ innovative activities. Several robustness checks including three proxies for firm performance and four instrumental-variable analyses confirm our original results. JEL Classification: E66, O31, G32