An Empirical Study Of The Impact Of Technological Innovation On Company Operating Performance And Stock Return And Its Mechanism

Technological innovations raise the expected productivity and profitability of the firms,improve overall efficiency and reduce investment costs.By constructing the TG(Technological Growth Option)variable to measure the relative importance of technological growth options versus asset in place,I find that technological innovations have significant impact on firm's operating performance,operating risks and expected return of stock returns.Furthermore,I studied the mechanism behind the impact of technological innovations have on stock returns.Lastly,I constructed the LMT factor to distinguish the Technological Growth Option factor from other existing risk factors.To evaluate the relative importance of technological growth options brought by technological innovations versus asset in place,I constructed the TG measure of the firms from 1961 to 2011 using the patent database developed by Kogan,Papanikolaou,Seru and Stoffman(2016).Specifically,I construct the TG measure by dividing total number of patents granted to firm i during last 3 years by firm's value.Patent is the product of firm's innovative activities.The more the number of patents a firm has,the greater the chance it has to grow.Thus,total number of patents a firm has is a proxy of firm's technological growth options.In order to evaluate the value of technological growth options a firm has,I construct another TG measure by dividing total value of patents granted to firm i during last 3 years by firm's value.The greater the value of patents a firm has,the greater the growth it will have by executing technological growth options.The value of patents is calculated using the method developed by Kogan,Papanikolaou,Seru and Stoffman(2016).I first conduct an empirical research to study the relationship between technological growth option brought by technological innovations and firm's operating performance.By conducting the annual Fama-Mac Beth(1973)cross-sectional regressions,I verified the intuition that technological innovations has significant positive impact on firm's future operating performance.Specifically,technological growth options have significant positive impact on firm's next year of ROE,ROA and Cash Flow.I then conduct an empirical research to study the relationship between technological growth option brought by technological innovations and stock returns.First,I construct a factor-mimicking portfolio of technological growth options.I then examine whether the returns of the TG portfolios are captured by standard factors by regressing the time-series of size-adjusted portfolio excess returns on the Carhart(1997)four factors returns,the Fama and French(2016)five factors returns and the Hou,Xue,and Zhang(2015)q-factor returns.I find that all risk-adjusted returns increase monotonically with the TG measure.Also,I find that all risk-adjusted returns of the zero-cost portfolios are significantly positive at the 1% level.I then examine the ability of TG to predict the cross section of returns using monthly Fama-Mac Beth(1973)regressions.This analysis allows me to control more extensively for other characteristics that can predict returns,to make sure that the positive TG-return relation as measured in portfolio sorts is not driven by other known return predictors or by industry characteristics.The result shows that the predictive power of TG is distinct from,and robust to the inclusion of,other commonly known return predictors and innovation-related variables.In order to study the mechanism behind the impact of technological innovations have on stock returns,I first study the relationship between technological growth options and operating risk.The result shows that technological growth options are significantly positively correlated with firm's operating risk.It means that technological innovations significantly increase firm's future operating risk.I then examine whether the returns of the TG portfolios are captured by factors related to investors behavior bias by regressing the time-series of size-adjusted portfolio excess returns on the Hirshleifer and Jiang(2010)UMO factor returns and the Fama and French(2016)five factors returns.The result shows that the UMO factor cannot explain the returns of the TG portfolios.In addition,by analyzing the factor loadings,I find that the profitability of high TG portfolio is lower than that of low TG portfolio,while the investment growth of high TG portfolio is lower than that of low TG portfolio.It means that firms with more technological growth options were less profitable and devoted more resource into innovative activities instead of capital investment during last few years.This is consistent the hypothesis that the positive relationship between technological growth options and stock returns is from its impact on firms operating risk.To further distinguish the two mechanisms behind the positive TG-return relation,I conduct monthly Fama-Mac Beth(1973)regression with subsamples split by firms' idiosyncratic risk(IDVOL)and operating performance such as ROE,ROA and Cash Flow.The result shows that the TG-return relation is significantly positive only among firms with high IDVOL,Low ROE,Low ROA and Low Cash Flow.Also,the crosssubsample differences in the TG slopes are all statistically significant.It means that technological growth options have more influence on firms with worse operating performance.This is consistent with the hypothesis from the neoclassical q theory and the real-option theory that the positive effect of technological growth options has on stock returns is from its impact on firms operating risk.I then conduct monthly FamaMac Beth(1973)regression with subsamples split by size,firm's age,institutional ownership and stock's illiquidity to test whether the positive TG-return relation is caused by investor's limited attention or stock's short-sale constraint.The result shows that all cross-subsample differences in the TG slopes are statistically insignificant.It implies that the positive TG-return relation is not caused by investor's limited attention or stock's short-sale constraint.To further understand if the TG-return relation is driven by risk or mispricing(or both)and if the TG effect reflects commonality in returns not fully captured by existing factors,we construct a factor-mimicking portfolio for technological growth option,LMT(Leading minus Trailing),based on TG following the procedure in Fama and French(1993).The result shows that from 1961 to 2012,the average monthly returns of the LMT factor(LMT1 and LMT2)are 0.36% and 0.38%,respectively.The sharpe ratio of the two LMT factor is 0.21 and 0.13,which is better than the market portfolio.At the meantime,the LMT factor is able to provide a good hedge against aggregate market downturns.Adding the LMT factor to tangency portfolio greatly improves its performance.The reason that LMT is so important for forming a mean-variance optimal portfolio is that it provides a substantial average return with a very low standard deviation,and has a very low correlation with existing risk factors.It means that the risk that the LMT factor stands for is significantly different from other risk factors.