Failures and Innovation: Evidence from Medical Device Recalls
George Ball (Indiana University (Kelley))
Jeffrey Macher (Georgetown University (McDonough))
Ariel Stern (Harvard Business School)

Abstract : Medical technology firms seek to operate at the frontiers of innovation and new product development. When functioning properly, innovative medical devices can prolong and improve lives; when malfunctioning, the same devices can cause harm to patients, lead to product recalls by regulators, and disrupt status-quo operations by manufacturers. Medical device firms’ innovation efforts are therefore likely to be affected by product failures. Using 13 years of firm-level FDA data, this paper explores the effects of product recalls on new product submissions. Recalls vary by source (firm or rival), proximity (product area) and severity (classification), while product submissions vary based on technological sophistication and novelty. Recurrent-event hazard models are used to examine how recalls affect the hazard of major and minor innovation. The empirical results are informative: first, own-firm recalls decelerate and rival-firm recalls accelerate the rate of innovative activity; second, same product area recalls slow innovative activity more than different product area recalls; and third, severe recalls decelerate innovative activity more than non-severe recalls. The results suggest that product failures significantly influence firms’ subsequent innovation efforts, but these relationships are highly nuanced. The strategic and public policy implications that obtain from these findings are highlighted and discussed.

The Effects of Downstream Competition on Upstream Innovation and Licensing
Jean de Bettignies (Queen's University)
Bulat Gainullin (Gulf Capital)
Huafang Liu (Queen's University)
David T. Robinson (Duke University)

Abstract : We consider an upstream innovator and two downstream competitors; and examine the impact of product market competition on the innovator's R&D strategy, when she can license her innovations to either one downstream competitor (targeted licensing) or both (market-wide licensing). We show that downstream competition unambiguously increases the appeal of targeted licensing over market-wide licensing. Moreover, competition increases the innovator's incentives to innovate under targeted licensing, but decreases these incentives under market-wide licensing. Thus, a threshold level of competition may exist such that above (below) that threshold, targeted (market-wide) licensing is optimal and innovation is increasing (decreasing) in competition. Using U.S. data across all industries over the years 1976 - 2006, we find empirical evidence that downstream competition has an U-shaped impact on upstream innovation. Data on licensing deals provides further empirical support that upstream innovators' licensing strategy is the underlying economic mechanism. In particular, as downstream competition intensifies, targeted licensing strategy becomes more appealing to upstream innovators than market-wide licensing.

Public Governance, Corporate Governance, and Firm Innovation: an Examination of State-owned Enterprises
Nan Jia (University of Southern California)
Kenneth G. Huang (National University of Singapore)
Cyndi M. Zhang (Singapore Management University)

Abstract : Innovation activities create substantial firm value, but they are difficult to manage owing to agency risks which are commonly thought to result in shirking hence underinvestment in innovation. However, agency risks can also create inefficient allocation of resources among innovation activities, on which the literature provided limited understanding. We examine an important type of agency risk-that agents pursue quantity of innovation at the expense of novelty, and how it is influenced by corporate and public governance. We theorize that improved corporate governance tools, including better alignment of agents' private incentives and stronger monitoring, and high-quality public governance reduce such agency risk in state-owned enterprises (SOEs). Furthermore, high-quality public governance enhances the functioning of corporate governance tools in further reducing this agency risk in innovation. We test our theory in the context of Chinese SOEs that responded to state's pro-innovation policies relying disproportionately on quantifiable outcomes (e.g., patent counts) for assessing innovation performance. Our difference-in-differences estimates provide overall support for the hypotheses. These findings provide new insights on how agency risk affects innovation by distinguishing the consequences on quantity and novelty of innovation and on how conventional corporate governance tools shaping innovation is dependent on public governance of institutional environment.