The Stock Market Anomaly of Innovative Efficiency: A Study of Innovative Efficiency and Stock Returns in the European Market Between 2013-2022

Abstract

This thesis studies the relationship between a firm’s efficiency in innovative efforts and stock returns. Following existing innovation anomaly studies, we explore if a trading strategy based on innovative efficiency measured by patents scaled by R&D expenditures can provide investors with abnormal returns. To test the persistence of the innovation anomaly across time and place, we increase the scope of the literature by investigating the relationship amongst European headquartered firms in the period 2013- 2022. Based on existing literature, we argue that investors have difficulties processing information that is less tangible and that this creates opportunities for investors that can estimate the future success of innovative efforts and make informed investment decisions. As we believe that investors neglect the importance of long-term innovation efforts, we expect that stocks with high (low) innovative efficiency are on average undervalued (overvalued). Due to this, we expect to find that investors can create investment strategies that provide abnormal returns. In contrast to expectations, we do not find that patents scaled by R&D expenditures can provide investors with abnormal returns. Even though we find that innovative efficiency to some extent does provide incremental information to existing risk factors, we find only limited signs of abnormal returns. Our findings show a small and positive excess return as well as a risk adjusted return above the market. However, the alpha is insignificant and hence, this rejects the notion of investors not being able to process less tangible information. As the results differ from findings in existing innovative efficiency anomaly literature, it raises the question of whether the innovative efficiency anomaly is persistent across countries and time periods. The thesis contributes to the growing market anomaly literature and provides the readers with theoretical suggestions towards an active investment strategy based on innovative efficiency. By doing so, the thesis can act as guidance to practitioners and hedge fund analysts and hence expand the scope of the business practice within active investment.