Skip to main content


Log in

Threat of termination and firm innovation

  • Research Article
  • Published:
Annals of Finance Aims and scope Submit manuscript


This study investigates how the ex-ante threat of termination affects firm performance in innovation measured by number of patents and citations. Empirical results show that the threat of termination is negatively associated with both measures of firm innovation. This relation however is sensitive to industry structure. The negative effect of the threat of termination on innovation is statistically significant only for high-tech firms. For low-tech firms there is no statistically significant relation between the threat of termination and firm innovation. One plausible explanation is that high-tech firms are inherently risky and have higher rates of project failure. Adding the risk of higher threat of termination makes the manager more risk averse and forces her to avoid investing in value increasing innovations. Managers in low-tech firms don’t face such pressures. The policy implication is that high-tech firms should lower threat of termination and increase tolerance for project failure to encourage innovation.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Similar content being viewed by others


  1. The file NBER PDP Project User Documentation: matching patent data to Compustat firms is available at along with updated NBER patent data.

  2. Since TOT is a predicted variable, I use bootstrap method with 500 reps to correct standard errors of all control for forecasting error.

  3. I also define high-tech firms as firms with R&D to Sales ratio above sample mean and find similar results.


  • Bhagat, S., Welch, I.: Corporate research and development investments: international comparisons. J Account Econ 19, 443–470 (1995)

    Article  Google Scholar 

  • Black, F., Scholes, M.: The pricing of options and corporate liabilities. J Polit Econ 81, 637–654 (1973)

    Article  Google Scholar 

  • Blundell, R., Griffith, L., Reenen, J.: Market share, market value and innovation in a panel of British manufacturing firms. Rev Econ Stud 66, 529–554 (1999)

    Article  Google Scholar 

  • Cefis, E., Marsili, O.: Survivor: the role of innovation in firms’ survival. Res Policy 35, 626–641 (2006)

    Article  Google Scholar 

  • Cockburn, I., Henderson, R.: Public-private interaction and the productivity of pharmaceutical research. Proc Natl Acad Sci USA 93, 12725–12730 (1996)

    Article  Google Scholar 

  • Coles, J.L., Daniel, N.D., Naveen, L.: Managerial incentives and risk taking. J Financ Econ 79, 431–468 (2006)

    Article  Google Scholar 

  • Core, J., Guay, W.: Estimating the value of employee stock option portfolios and their sensitivities to price and volatility. J Account Res 40, 613–630 (2002)

    Article  Google Scholar 

  • Dechow, P., Sloan, R.: Executive incentives and the horizon problem: an empirical investigation. J Account Econ 14, 51–89 (1991)

    Article  Google Scholar 

  • Eberhart, A., Maxwell, W., Siddique, A.: An examination of long-term abnormal stock returns and operating performance following R&D increases. J Financ 59, 623–650 (2004)

    Article  Google Scholar 

  • Fee, E., Hadlock C.J.: Management turnover across the corporate hierarchy. Working Paper, Michigan State University (2002)

  • Flor, C.R., Hansen, S.L.: Technological advances and the decision to invest. Ann Financ 9, 383–420 (2012)

    Article  Google Scholar 

  • Geroski, P., Machin, S., Reenan, J.V.: The profitability of innovating firms. RAND J Econ 24(2), 198–211 (1993)

    Article  Google Scholar 

  • Gibbons, R., Murphy, K.J.: Does executive compensation affect investment? J Appl Corp Financ 5, 99–110 (1992b)

    Article  Google Scholar 

  • Griliches, Z.: The search for R&D spillovers. Scand J Econ 95, 29–47 (1992)

    Article  Google Scholar 

  • Griliches, Z.: R&D, patents, and productivity. In: NBER Conference Proceedings: Chicago: University of Chicago Press (1984)

  • Guay, W.: The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants. J Financ Econ 53, 43–71 (1999)

    Article  Google Scholar 

  • Hall, B.H., Jaffe, A., Trajtenberg, M.: Market value and patent citations. Rand J Econ 36(1), 16–38 (2005)

    Google Scholar 

  • Hall, B.H., Jaffe, A., Trajtenberg, M.: The NBER patent citation file: lessons, insights, and methodological tools. In: Jaffe, A., Trajtenberg, M. (eds.) Patents, Citations and Innovations: Cambridge: The MIT Press (2002)

  • Holmstrom, B.: Agency costs and innovation. J Econ Behav Organ 12(3), 305–327 (1989)

    Article  Google Scholar 

  • Huson, M., Parrino, R., Starks, L.: Internal monitoring mechanisms and CEO turnover: a long term perspective. J Financ 56, 97–2265 (2001)

    Article  Google Scholar 

  • Jaffe, A.B., Trajtenberg, M., Fogarty, M.S.: The Meaning of Patent Citations: Report on the NBER/Case-Western Reserve Survey of Patentees. NBER Working Papers 7631, National Bureau of Economic Research, Inc. (2000)

  • Jensen, M.C., Meckling, W.H.: Theory of the firm: managerial behavior, agency costs and ownership structure. J Financ Econ 2, 60–305 (1976)

    Google Scholar 

  • Jensen, M., Murphy, K.: Performance pay and top management incentives. J Polit Econ 98(2), 64–225 (1990)

    Article  Google Scholar 

  • Koeller, T.C.: Innovation, market structure and firm size: a simultaneous equations model. Manag Decis Econ 16(3), 259–269 (1995)

    Article  Google Scholar 

  • Lanjouw, J.O., Schankerman, M.: Patent quality and research productivity: measuring innovation with multiple indicators. Econ J 114(495), 441–465 (2004)

    Google Scholar 

  • Morck, R., Shleifer, A., Vishny, R.: Alternative mechanisms for corporate control. Am Econ Rev 79, 842–852 (1989)

    Google Scholar 

  • Merton, R.: Theory of rational option pricing. Bell J Econ Manag Sci 4, 141–183 (1973)

    Article  Google Scholar 

  • Manso, G.: Motivating innovation. J Financ LXVI 5, 1823–1860 (2011)

    Article  Google Scholar 

  • Scherer, F.M.: Inter-industry technology flows and productivity growth. Rev Econ Stat 64, 627–634 (1982)

    Article  Google Scholar 

  • Schmookler, J.: Invention and economic growth: Cambridge: Harvard University Press (1996)

  • Smith, C.W., Stulz, R.M.: The determinants of firms’ hedging policies. J Financ Quant Anal 20(4), 391–405 (1985)

    Article  Google Scholar 

  • Stein, J.C.: Takeover threats and myopia. J Polit Econ 96, 61–80 (1988)

    Article  Google Scholar 

  • Trajtenberg, M.: A penny for your quotes: patent citations and the value of innovations. Rand J Econ 21(1), 172–187 (1990)

    Article  Google Scholar 

  • Weisbach, M.: Outside directors and CEO turnover. J Financ Econ 20, 431–460 (1988)

    Article  Google Scholar 

  • Xue, Y.: Make or buy new technology: the role of CEO compensation contract in a firm’s route to innovation. Rev Account Stud 12(4), 659–690 (2007)

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations


Corresponding author

Correspondence to Shahbaz Sheikh.



1.1 Truncation bias in patent counts

The truncation bias in patent counts exists because there is an average lag of 2 years between the time an application is filed and the time the patent is granted. This is not a problem in the beginning of our sample (1990) as the average patent filed by the year 1990 was granted by the year 1992. However, as we approach towards the end of the sample the data does not report the patents that will eventually be granted in the coming few years. We therefore observe large number of missing patent data in the last years of the sample. Hall et al. (2002, 2005) show that correcting the truncation bias in patent counts is simple and straight forward. We follow Hall et al. (2005) to correct the truncation in patent counts. The method involves in calculating weight factors based on the application-grant distribution of patents in the sample and then multiplying number of patent counts by the respective weight factors. The patent counts are corrected for the years 2001–2006. Based on Hall et al. (2005) the following formula is used to correct for the truncation in patent counts.

$$\begin{aligned} \text {Patent}_{\mathrm{t}}=\frac{patent_t}{\mathop \sum \nolimits _{k=0}^{2005-t} weight_k } \quad 2006 \le \mathrm{t} \ge 2001 \end{aligned}$$

1.2 Truncation bias in citations

The truncation bias in citations exists because citations to a patent keep on coming long after the patent was granted but we only observe citations in the data that are available by the last year of the data. Hall et al. (2002, 2005) use the “quasi-structural” approach to correct the truncation bias in citations. They first estimate the life time citation-lag distribution over the entire data period (1976–2006). Given this distribution they estimate the total citations of any patent for which only a portion of its citations life is observed by dividing the observed citations by the fraction of the population distribution for the time interval during which the citations are observed. A detailed description of the method can be found in Hall et al. (2002). We don’t need to correct for the truncation bias in citations in our sample as the updated NBER data now provides truncation corrected data on citations using Hall et al. (2002).

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Sheikh, S. Threat of termination and firm innovation. Ann Finance 13, 75–95 (2017).

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI:


JEL Classification