Essays on corporate innovation strategy and corporate disclosure

This thesis consists of three essays about the role of corporate innovation strategy in corporate disclosure. Innovation is crucial in helping firms gain a competitive edge and sustainable growth. While firms increasingly and continuously invest more resources into innovative activities, their innovation strategies exhibit substantial variations. Innovation strategy is a significant way to guide firms’ innovation efforts and facilitate trade-off decisionmaking. There are two types of corporate innovation strategy: exploration and exploitation.

Exploration innovation strategy emphasises the exploration of new possibilities, whereas exploitation innovation strategy focuses on the exploitation of existing certainties. Given that the difference between exploration and exploitation is connected with firm behaviour that significantly influences firms’ underlying earnings stream and disclosure environment (He and Wong, 2004; March, 1991), this thesis examines how firms’ choice of innovation strategy impacts corporate disclosure. Specifically, the thesis contains three empirical studies about the impact of innovation strategy on the characteristics of financial reporting, earnings, and voluntary disclosure, respectively.

The first empirical work studies the impact of innovation strategy on accounting conservatism.

The results show that exploration-oriented firms report more conservatively than exploitation-oriented firms. Cross-sectional tests indicate that the positive relationship between exploration innovation strategy and accounting conservatism is statistically significant only for firms with greater information asymmetry, higher stock price crash risk, a higher failure-to-success ratio and higher managers’ litigation risk. The evidence supports that accounting conservatism in exploration-oriented firms can be explained as a rational response to uncertainty.

The second empirical work studies the impact of innovation strategy on income smoothing and the magnitude of accruals. Income smoothing and the magnitude of accruals present two important properties of earnings. Using a composite measure of income smoothing and accruals, this study suggests a positive (negative) relationship between exploration (exploitation) innovation strategy and income smoothing and the magnitude of accruals.

Evidence suggests that income smoothing and the magnitude of accruals in exploratoryoriented firms are beneficial from the perspective of improving firm value and earnings informativeness. Cross-sectional tests indicate that the positive relationship is statistically significant for firms with more analyst coverage. The findings of this study shed light on the role of innovation strategy in shaping earnings properties of income smoothing and the magnitude of accruals.

The third empirical work studies the impact of innovation strategy on non-GAAP earnings. The baseline results suggest that firms pursuing an exploitation-oriented (explorationoriented) innovation strategy are positively (negatively) associated with the likelihood and magnitude of non-GAAP exclusions. The study also provides insight that exploitation innovation strategy affects the likelihood and magnitude of non-GAAP exclusions in the form of other exclusions. Moreover, the cross-sectional tests show that exploitation-oriented firms report more aggressive non-GAAP earnings when firms have a higher information asymmetry environment. This study also tests the quality of non-GAAP exclusions and finds that non-GAAP exclusions defined by exploitative firms are persistent and, thus, low-quality.

The findings of this study advance our understanding of how a public company’s choice of innovation strategy affects its disclosure practice of non-GAAP earnings.