CORPORATE GOVERNANCE, INNOVATION EFFORT, AND FIRM PERFORMANCE
2.6 Discussion of Empirical Findings
0.7% and 0.04% respectively, when corporate governance performance goes up by 1 score point. Results remain robust when modelling firms with zero R&D expenditures differently in the Tobit estimation. A significant and positive relationship between corporate governance and R&D expenditures can still be found. In the Tobit estimation, R&D expenditures increases, on average by 28,385,000 USD, when corporate governance performance goes up by 1 score point. The relationship for both R&D/Total Sales and R&D/Total Assets also remains significant and negative.
R&D/Total Sales and R&D/Total Assets decreases, on average by 1.2% and 0.7%
respectively, when corporate governance performance goes up by 1 score point. This result suggests that better corporate governance performance is associated with higher investments in R&D, but weaker R&D intensity of firms. In other words, the better a firm performs in meeting corporate governance yardsticks, the more likely it is to have overall lower R&D intensity despite having higher investments in R&D.
The results overall challenge the theoretical framework proposed for the current study based on agency theory. While the intention of the model is to reflect the view that corporate governance has potential of being utilized to promote an environment where the CEO is motivated and effectively supervised to innovate, results reveal otherwise. The findings suggest that shareholders could be promoting effective corporate governance practices that create incentives among managers for maximizing the value of their investment that deviates away from efficient utilization of R&D expenditures for firm innovation effort. Hence, in the context of the innovating firm, it is not always the case that effective corporate governance practices promotes efficient firm innovation effort.
The extant literature offers some evidence and discussion in line with the findings of the current study. In the context of the innovating firm, both internal and external corporate governance mechanisms could in some situations lead to decreased or more inefficient firm innovation effort. For instance, in terms of internal corporate governance mechanisms, Honore et al. (2015) find that the more consensual the vote at the shareholders assembly then the lower the R&D intensity among 177 European companies (2003-2007). This suggest that when there is a large consensus at the annual general meeting between shareholders and managers, it is likely in favor of short-term decisions as opposed to long-term projects that involve R&D investment.
The study also observes that financial performance based remuneration have a negative effect on R&D intensity of large publicly traded European companies. This suggests that even though financial incentives could align interests of shareholders and managers, incentive effects appear limited to short-term results that can lower R&D intensity.
2.6.2 How is Firm Performance Impacted?
The study’s second research question further explored the impact of a firm’s innovation effort on its performance, for the same panel dataset. Specifically, the second research question addresses the relationship between firm innovation and firm ROA, ROE and EPSFI (selected proxies for firm performance). Based on results of the data analysis for this research question, it is overall found that a firm’s innovation effort has no positive effect on its profitability, while holding other variables constant.
The OLS results reveal a significant (but negative) relationship between R&D/Total Sales with ROA and EPSFI. Overall results are not consistent with the proposed mediation hypothesis. No effect of a firm’s innovation effort on its performance is found. The results remain robust when modelling firms with zero R&D/Total Sales differently in the Tobit estimation. The relationship between R&D/Total Sales with firm ROA and EPSFI still remain significant and negative..
Findings of the study differ from the Zhang et al (2014) study that find R&D investment to mediate the relationship corporate governance and performance of Chinese listed IT firms.
Additionally, a significant and positive effect is found between firm level corporate governance performance and EPSFI. EPSFI increases on average by 9.4%
when corporate governance performance goes up by 1 score point. Results remain robust when modelling firms with zero R&D expenditures differently in the Tobit estimation. A significant and positive relationship between corporate governance and EPSFI still exist. In the Tobit estimation, EPSFI increases, on average by 9.4% when corporate governance performance goes up by 1 score point.. This result offers some evidence to suggest that better alignment of incentives between shareholders and firm
management (through better corporate governance performance) leads to a focus on increasing short-term profits that deviates away from innovation effort.
Overall results offer differing evidence that lacks support for the notion that a firm’s corporate governance performance plays a key role in driving the relationship between a firm’s innovation efforts (i.e., increase in R&D investment) and its performance. No evidence for an overall positive relationship between firm level corporate governance and innovation effort is found in the current study. In turn, it is also found that innovation effort has no positive effect on firm profitability. Therefore, the expected mediating relationship from better corporate governance to more firm innovation effort to enhanced firm performance is not supported in the current study.
On the other hand, the empirical findings suggest that an emphasis on enhancing firm short-term profitability through improved corporate governance that better aligns incentives between shareholders and firm management comes at the expense of firm innovation. A plausible explanation for this trend could be related to the investor sentiment and the risk associated with innovation effort. While innovation can be considered a driving force for firm economic success that promotes firm value and enhance long-term growth of innovative firms, the risk and costs associated with innovation can also be anticipated to impact a firm’s value and performance negatively.
Aside from the view that investment decisions are made to maximize shareholder wealth, managers may in practice have incentives to go after short-term sub-optimal investments so as to accommodate the investor sentiment. In the context of investment decisions, shareholders are viewed as risk neutral as they have the ability to diversify their overall investment across several firms. Managers on the other hand are viewed as risk-averse as a result of being able to put their effort into only one job (Honore et al., 2015). In such a situation managers would favor short term gains brought about by efficiency-seeking strategies. This could hinder innovation and long- term returns.