In this interview, Chris Malloy discusses his research finding that firms with proven track records of success with research and development (R&D) investment are not rewarded by the market compared with firms that are unsuccessful with a similar level of investment into R&D. Malloy claims that the market is not very good at assessing the value of innovation because it does not distinguish between “good” innovators and “bad” innovators.
In this interview, Chris Malloy of Harvard Business School discusses his research that indicates that the market does not reward what will likely be profitable innovations produced by firms that invest heavily in research and development (R&D). Malloy finds that firms with good track records of implementing R&D (i.e., innovation) over a five-year period tend to outperform the market by 78 bps, whereas firms with poor track records over the same period underperform the market by 15 bps. He looks at firm performance between 1980 and 2009, and his research appears to be biased neither by the time period of the data sample nor by a U.S. focus.
Malloy also discusses some of his current research that follows legislative voting by politicians with certain industry interests. His hypothesis is that policy driven by politicians with a particular industry interest will lead to better performance for that industry in the near future.
How Is This Article Useful to Practitioners?
The immediate benefit to the practitioner is the possibility, as suggested by Malloy, of a long–short strategy—long “good” innovators and short “bad” innovators. During the 1980–2009 sample period, an investor using such a strategy could have realized an 11% annual return.
Malloy’s current work looks at legislation that favors a given industry alongside the voting patterns of politicians who also favor that industry. Voting patterns might be indicators of future success for the industry. Should the premise be demonstrated to be consistently true, another long–short strategy may emerge.
From a broader perspective, practitioners will benefit from Malloy’s demonstration that investment should be based on a sound economic premise in which success or indicators of success (such as a past track record of successful implementation of R&D) attract investment.
Given that the article is an interview, it is difficult to assess whether good innovators beat the market or simply produce a return that is risk appropriate. Setting this issue aside, the question I am left with is, how easily implemented is the long–short strategy Malloy suggests? The market may actually be “ignoring” innovation because the stocks are thinly traded, making such a strategy theoretically possible but impractical. Again, the interview format may be preventing a full understanding of this aspect of the research.
But I do like the idea of implementing strategy on sound economic principles rather than, say, a strategy of timing a particular market fluctuation that is not information driven.