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Even though it is considered as the engine for technological progress and long-term prosperity, Professor Houdou Basse Mama highlights the difficulties investors face when valuing science-based innovation, but also provides solutions to alleviate them.

According to the Organization for Economic Cooperation and Development (OECD), innovation is a key driver of economic growth - at least 50% of it can be attributed to innovation – and also a prime source of competition in the global marketplace. But less and less innovation originates within firms and “open-market” or “open” innovation, corporate accelerators, business incubators, etc. have had the wind in their sails. “Companies increasingly recognize the value of external knowledge flows and are shifting away from the insular innovation culture,” writes ESCP Europe Professor of Finance Houdou Basse Mama in the article he published in Research Policy. He cites a recent study which found that of the 16% of U.S. manufacturing firms with major innovations between 2007 and 2009, 49% of the innovations originated from identified outside sources. At the same time, large firms in the U.S. and Europe are withdrawing from open science, although scientific knowledge continues to be a useful input in firms’ innovation programs. This transformation entails a redirection from more exploratory scientific research toward more product development and commercialization.

Financing constraints stemming from difficulties in valuing innovation
“There is growing consensus that well-functioning financial markets play a central role in driving economic growth through their ability to spur technological innovation,” explain Harvard Professors William R. Kerr and Ramana Nanda. But also that “financing constraints can be extensive in the context of firms engaged in R&D and innovation-with the ability to shape both the rate and the trajectory of innovation.”
“To effectively finance innovation activities, investors need to adequately value them,” adds Professor Basse Mama. “Disruptive innovation is all too often science-based but firms that show such a search process face financing constraints due to mispricing by capital providers.” This is why he chose to study the link between firms’ scientific capabilities and their capital market payoffs. Using patent data from the European Patent Office (EPO) relative to 3281 international firms over the 1999–2015 period, he explored through empirical tests the extent to which cross-sectional differences in firms’ propensity to absorb and utilize scientific knowledge matter for their stock market and operating performance. Unlike prior empirical studies, he accounted for the coexistence of both benefits and costs inherent in science-led search and hypothesized a non-monotonic relationship.

Implications for firms, investors, policymakers, the investment and security analysis industry
The holder of the Chair of International Financial Markets (Berlin campus) provided robust evidence of a nonlinear relationship between the closeness of a firm's patents to science (a generally accepted measure of science-led innovation search) and stock market and operating performance. He recommended that firms should consider the decreasing marginal payoff to calling on science when innovating. More importantly, he showed that firms’ scientific capabilities positively moderate this relationship. “Besides, the association between science and future operating performance increases with time, indicating that firms’ scientific capabilities are a potent driver of long-term profitability.”
This study provides a useful basis upon which to judge the economic merit of firms’ innovation endeavours, and thus contributes to spurring private-sector investment in R&D. “There is strong evidence that firms in innovative-intensive industries are more dependent on external equity finance. Given the value-relevance of firms’ scientific capabilities, standard setters might find it judicious to induce firms to disclose that information, thereby reducing capital market imperfections that curtail access to external finance,” he adds. However, this requires a trade-off between transparency and revealing proprietary information to competitors.
By proposing an effective patent-related investment signal, this work is also valuable to the investment and security analysis industry, where patent attributes are still scantily used.
Finally, the evidence is likely to be relevant to policymakers, who might wish to influence the innovation ecosystem in a way to sustain long-term prosperity: “Given the evidence of a decline of science in corporate R&D, country-level improvements of university research systems are likely to promote industrial innovation, and with it long-term prosperity. This evidence makes a cautious case for governmental support of science.”