Novelty or Efficiency? Which Matters Most for Firm Performance

Abstract

In this study, we examine whether firms disclose their innovative qualities through their textual filings and, if so, whether these disclosures may help understand the intangible capital of a firm that is generally not recognized in financial statements. Using the introduction of novelties to firms’ business descriptions in their 10-K filings, we develop a novel text-based innovation measure, which is particularly appealing for firms operating in non-R&D industries that offer innovative products and services. Our innovation measure captures not only firms’ product and service innovations but also innovations in business models or organizational methods, which are not captured by conventional innovation proxies. We find that novelties introduced in firms’ textual filings help explain future sales growth, operating profitability, and capital market performance beyond historical accounting numbers. We find that not only R&D investments but also SGA expenses related to intangible capital explain the variation in our text-based innovation measure. Our study extends the earlier work showing the usefulness of textual disclosures in terms of assessing a firm’s degree of innovation (intangible capital) and contributes to the long-standing debate regarding the recognition of intangibles in financial statements.

Mustafa Ahçı

Assistant Professor of Accounting

My research interests include corporate disclosures, corporate innovation, capital markets.