Do Managerial Practices Matter in Innovation and Firm Performance Relations? New Evidence from the UK

• Date: 01 October 2017
• Published date: 01 October 2017
• DOI: http://doi.org/10.1111/eufm.12123

Do Managerial Practices Matter in

Innovation and Firm Performance

Relations? New Evidence from the UK

Ilayda Nemlioglu and Sushanta K. Mallick

School of Business and Management, Queen Mary University of London Mile End Road, London E1

4NS, UK

E-mails: i.nemlioglu@qmul.ac.uk; s.k.mallick@qmul.ac.uk

Abstract

The innovation and firm performance relationship remains a puzzle, as all types of

innovation are not equally beneficial. Besides, better-managed firms can perform

better. Integrating these two strands of literature, we examine whether managerial

practices explain this relationship using data from UK firms during 1992–2014.

We find that firms which focus on R&D activities jointly with better managerial

practices benefit favourably. During the post-crisis period, higher intangibles are

only beneficial when combined with R&D activity. Also firms with better

managerial practices and innovative activities exhibit a positive effect of higher

leverage. Finally, an inverse U-shaped result supports the Schumpeterian theory

of creative destruction.

Keywords: firm performance, firm profitability, financial crisis, leverage, intangi-

ble assets, R&D intensity, innovation, managerial practices, panel data models

JEL classification: C33,G01,G1,G3,O3,O32,O34

Earlier versions of this paper were presented at the following conferences, namely MMF

(Money, Macro and Finance Research Group) 2013 in London; EEFS (European

Economics and Finance Society) 2013 and 2014 in Berlin and Thessaloniki, respectively;

EPIP (European Policy on Intellectual Property) 2014 in Brussels at the European

Commission, and IFABS (International Finance and Banking Society) 2015 in Hang Zhou,

China. The authors would like to thank the Editor and the anonymous referee of this journal

for their very constructive comments and suggestions on an earlier version of this paper.

We are also thankful to Keith Pilbeam, Philip Rawlings and Michela Vecchi for their

comments in improving this paper. We are solely responsible for any errors that might yet

remain.

European Financial Management, Vol. 23, No. 5, 2017, 1016–1061

doi: 10.1111/eufm.12123

© 2017 John Wiley & Sons, Ltd.

1. Introduction

While investigating the relationship between innovation and firm performance, the key

unresolved question is whetherhigher intellectual capital is beneficial or unfavourable to

firm performance, as not all types of innovation positively influence firm performance.

Existing research in this regard remainsunclear on the effects of intangibles and does not

provide a consensus onhow to measure intellectual capital, given the declinein valuation

of intangibles followingthe global financial crisis. Evidence from studiessuch as Hall and

Oriani (2006)and Bloom and Van Reenen (2010) shows that productivitydifferences have

been the focus of researchers for decades and, traditionally, those differences were

attributed to R&D investments. In other words, the residual in production that is not

accounted for by the usual inputs (such as labour, capital and intermediate inputs) is

assumed to be the product of R&D that produces technical change.

1

For that reason, it is

vital to observe the impact of R&D on firm performance. On the other hand, Bloom and

Van Reenen (2007, 2010) and Bloomet al. (2012) argue that the literature fails to consider

the differences in managerial practices among firms that contribute to better firm

performance. In this paper, we try to integrate these two strands of literature, whilst also

considering therole of intangibles on firm performance in terms of profitabilityin the

pre-and post-crisis periods.

One strand advocates the i dea that performance diff erences across firms are the

result of different manageme nt practices (see Bloom and Van Ree nen (2007, 2010),

Bloom et al. (2012), Keller (2009, 2011)), while th e second strand of literature cent res

its arguments upon innovat ion activities by using R&D investment, R&D intensi ty and

related company intangib les as a proxy to explain dif ferences in firm performance.

However, as the studies that focus on mana gerial practices do not consider inno vative

activities such as R&D, paten ts, intangible assets, the R &D arguments (see studies

such as Hall (2010, 2011), H all and Oriani (2006) and Hall et al. (2007, 2009, 2010

and 2013)) become important si nce R&D activities explain pe rformance differences

across firms.

Another aspect emphasised by Hall (2010), Hall and Lerner (2010), Borisova and

Brown (2013) and Brown et al. (2012) relates to the role of financial constraints in R&D

activities by firms. The question then arises whether firms that are R&D and innovation-

based display differences in performance, after controlling for financial leverage. In

other words, we examine whether financial constraints impede innovation. Firms with

higher leverage ratios could have difficulties in financing innovation activities because

investors, banks or other finance providers usually seek tangible assets. When a company

does not have tangible assets, it is perceived as riskier, and investors are wary of

investing in them. Companies who are considered to be good performers are expected

to use their intangible assets (such as patents, brands, trademarks and trade secrets)

1

According to Hall (2011), even though some of the ideas discussed were estimated in his

1973 survey, Griliches (1979) is the first and pioneering analytic survey on this topic. In that

article, Griliches laid out the structure of the problem in the production function context and

discussed two major measurement difficulties: the measurement of output when a great deal

of R&D is devoted to quality improvement and non-market goods, and the measurement of

input, specifically, of the stock of R&D capital. Also, Griliches (1998) summarises all his

writings on this topic.

© 2017 John Wiley & Sons, Ltd.

Do Managerial Practices Matter in Innovation 1017

and create tangibles out of them. Successful companies may have higher levels of

intangible assets, but they are successful due to their ability to turn those innovative

activities into assets. On the other hand, start-up companies may have good ideas, but if

those intangible efforts are not transformed into assets, they are perceived as non-

performers.

While the literature on manage rial practices lacks a focus on R&D, inta ngibles

and firm financial constraints, t he R&D-focused literature ignores differences in

managerial practices whe n comparing firm performance. Therefore, this paper

combines both aspects to exami ne differences in firm performa nce. Besides, there is a

gap in both strands of liter ature in examining what h appens to R&D and innovativ e

activities during a crisis , and whether firms that are highl y innovative and those that

are better managed outperform o thers during the post-crisis pe riod. From the full

sample, we can see that the leverag e ratios appear dispersed but t hey vary differently

during pre- and post-crisi s periods. As shown in the de scriptive statistics, firms’

leverage ratios were higher in the pre-crisis, but in the post-cri sis period, leverage

started to decline. Moreo ver, previous literature h as not explored whether the se

differences (pre- and pos t-crisis) change the relati onship between R&D, manag erial

practices, and their impac t on firm performance.

This paper uses UK firm-level data over the period 1992–2014 to investigate the

impact of managerial practices and innovation on firm’s profitability. The paper is

motivated by four key questions. The first one examines the impact of intangible assets

and R&D activity on firm performance. The second question examines whether better

managerial practices matter for firm performance. Additionally, the third question

elaborates how better managerial practices and innovation impact firms that are

financially constrained. Finally, the fourth question examines how managerial practices,

R&D activity and intangible assets have impacted performance before and following the

recent financial crisis. We find that intangible assets together with R&D activity have a

positive impact on firm performance, as firms with only higher levels of intangible assets

do not always benefit. Additionally, following the crisis, firms with high R&D activity

experienced a positive effect of intangibles on performance, as total assets became more

important in improving firm performance rather than intangibles that did not reflect their

true valuation in the pre-crisis period. This paper suggests that firms with better

managerial practices tend to outperform, even when we consider the impact of the

financial crisis, distinguishing firms with higher innovation activities and better

managerial practices. Finally, the paper finds an inverse U-shaped relationship between

intangible assets and firm performance. In the remainder of the paper, section 2 presents

the literature review and hypotheses development. Section 3 examines the data and

methodology, section 4 presents empirical results and the robustness checks. Finally,

section 5 concludes the paper.

2. Literature Review and Hypotheses Development

2.1. Impact of intangible assets on firm performance

Various empirical studies show the impact of intangible assets on firm performance. The

best-documented and most widely researched area is research and development (R&D)

(see Marr et al. (2003, 2004)). The key approach in the majority of the early studies such

as Hall and Vopel (1997) and Hall et al. (2005, 2007) was to relate the market value of a

© 2017 John Wiley & Sons, Ltd.

1018 Ilayda Nemlioglu and Sushanta K. Mallick