Corporate governance drivers of firm innovation capacity

• Date: 01 August 2018
• Published date: 01 August 2018
• DOI: http://doi.org/10.1111/roie.12321

SPECIAL ISSUE PAPER

Corporate governance drivers of firm innovation

capacity

Alfredo M. Bobillo

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J.A. Rodríguez-Sanz

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F. Tejerina-Gaite

University of Valladolid, Valladolid,

Spain

Correspondence

Alfredo M. Bobillo, Department

Economic and Business, University of

Valladolid, Facultad de Econ

omicas y

Empresariales, 47011-Valladolid, Spain.

Email: alfredo.martinez@uva.es

Abstract

We investigate the predictive factors of firm innovation

capacity (FIC), proxied by intangible assets, as a means

towards sustainable competitive advantage in a world of

global change and innovation. The primary aim of this paper

is to identify the key factors shaping a firm’s innovation

capacity management style. We use panel data for 1,942

firms (20,171 observations) in Germany, France, Italy, the

United Kingdom, United States, and Spain, over the period

1999 to 2014. Our results show that capabilities driven by

corporate governance mechanisms currently constitute the

pivotal support for firms’innovation capacity (FIC). Our

main findings are that corporate governance drivers such as

executive incentives (E-P) and the presence of independent

nonexecutive directors (INEDs) have a bearing on FIC.

Meanwhile, managerial performance (MP) and institutional

shareholder activism (AI) emerge as basic motivational

instruments and mechanisms of alignment between firm

ownership and control. The influence of incentives and

INEDs is found to be negative and that of institutional share-

holder activism and MP to be positive. With respect to the

business context, we find evidence of higher efficiency in

firm disciplinary mechanisms in the Anglo-American than in

the Continental corporate governance model.

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INTRODUCTION

Innovation is of critical importance not only for firms, but for the growth and development of the econ-

omy as a whole. Thus, a frequent challenge for today’s businesses is to identify m echanisms that bo ost

innovation initiatives and distinguish them from hindering factors. Economic prospecting analyses

show a strong link between firm growth and success. However, cross-country differences also need to

be considered, as do institutional factors, which can have an implicit influence on the firm. Firms have

always been assumed to compete at the product level and may also compete in R&D (Falvey &

Rev Int Econ. 2018;26:721–741. wileyonlinelibrary.com/journal/roie V

C2017 JohnWiley & Sons Ltd

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DOI: 10.1111/roie.12321

Teerasuwannajak, 2016). Currently, firm innovation capacity (FIC) can be defined along the lines sug-

gested by Corrado, Hulten, and Sichel (2005, 2009), according to which intangible assets can serve as

a partial proxy for firm innovation. Given, moreover, that the evidence indicates more innovation in

intangibles than in tangibles (Bronwyn & Raffaele, 2006; Heirman & Clarysse, 2007), our focus is

based on a knowledge that intangible assets can provide firms.

In 1987, Solow famously remarked that “you can see the intangible revolution everywhere except

in firm productivity data.”There have been several firm-level studies on the impact of intangible

investment on firm value (Griliches, 2000). Miyagawa and Shoishi (2013) find that the accumulation

of intangible assets significantly increases firm value. The increasing importance of firms’acquisition

of intangible assets motivates us to develop our understanding of the role played by corporate gover-

nance mechanisms in the firm innovation process. Our aim is to develop a model simultaneously inte-

grating corporate governance mechanisms, intangibles and FIC.

Pavitt (2005) pointed out that firm-level innovation processes pose three simultaneous challenges:

(1) To identify and adopt practices that will enable the firm to create and maintain the knowhow

required for its activities;

(2) To organize the means to produce goods internally or in cooperation with other organizations;

and

(3) To develop and implement a scaled incentive system to guarantee the speed and effectiveness of

the innovation process.

We take a contractual view of the firm, based mainly on the principal–agent and incentives alignment

theories. We acknowledge, however, that this approach disregards a considerable set of noncontractual,

softer, and organizational drivers such as exploitation/exploration capacities, absorptive capacity, and

open innovation, to mention but a few on which at the time of writing date innovation studies have

focused.

Among the different approaches found in the innovation literature, a new school of thought has

arisen proposing innovation as an evolving and dynamic process linking the firm’sinnovationcapacity

to its corporate governance quality. It is worth noting that indications suggesting this link have been

described in papers from various areas of economic research, such as institutional ownership, manage-

ment and finance (O’Connor & Rafferty, 2012; Sapra, Subramanian, & Subramanian, 2013), where

individual factors with a potential impact on corporate governance quality are examined. What has yet

to emerge, however, is an integrated model of the various factors that would enable identification of

their potential synergies. We address this gap in the existing literature by presenting an integrated four-

faceted model of corporate governance mechanisms that considers the influence of the CEO pay–per-

formance link, management performance, independent-outside directors, and institutional investors.

The core of this research, therefore, revolves around how corporate governance mechanisms act as

the main drivers of FIC. We split our focus in two directions: internal governance mechanisms (CEO-

pay, independent-outside directors, institutional activism) and a hybrid governance mechanism (mana-

gerial performance). Previous studies (Gompers, Ishii, & Metrick, 2003; Mahoney, Sundaramurthy, &

Mahoney, 1997) suggest that, as executives become stronger or more entrenched, they gear the corpo-

rate governance strategy to their own interests at the cost of shareholders, while losing any incentive to

undertake long-run projects, such as innovation investments. There is, however, only very weak evi-

dence to support the view that a good governance structure boosts innovation investment. Three factors

motivate this research. The first is that, whereas previous studies have examined the individual impact

of several different corporate governance control mechanisms on firm innovation, we aim to investi-

gate the possibility of various corporate governance mechanisms having a joint impact on firm

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