Academic journal article Financial Management

How Does Strategic Competition Affect Firm Values? a Study of New Product Announcements

Academic journal article Financial Management

How Does Strategic Competition Affect Firm Values? a Study of New Product Announcements

Article excerpt

We examine the role of strategic interaction in explaining the valuation effect of new product announcements and employ Sundaram. John, and John's (1996) competitive strategy measure to operationalize the nature of a firm's competitive interaction. Using a sample of new product introductions between 1991 and 1995, we find that the market values introductions announced by firms in strategic substitutes competition more favorably than those announced by firms in strategic complements competition. These results hold after we control for other variables that could explain the announcement effect. We also find that industry rivals of those announcing firms that compete in strategic substitutes and experience a positive announcement effect generally suffer a small, but significant wealth loss. The evidence supports the notion that the nature of competitive interaction in an industry is important in assessing the effect of corporate product strategies on shareholder value.

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Cheng-few Lee (*)

Previous studies show that announcements of new product strategies are generally associated with a positive effect on shareholder value (Woolridge, 1988; Chaney, Devinney, and Winer, 1991; Kelm, Narayanan, and Pinches, 1995; and Chen and Ho, 1997). Chaney et al. (1991) find that the value of a new product announcement is higher for firms in more technologically based industries and for firms that make original- or multiple-product announcements. They find that the value is lower for firms that make frequent product announcements. Chaney et al. (1991) also find that higher short-term interest rates have a negative impact on the value of new product introductions. Kelm et al. (1995) find that the announcement-period returns are negatively related to firm size and industry-wide R&D intensity and positively related to announcement frequency and industry concentration. Chen and Ho (1997) find that new product strategies by firms with good investment opportunities are generally regarded as worthwhile, and those by firms with poor investment opportunities are not. They find that free cash flow has no explanatory power.

Although these empirical studies on the wealth effect of new product strategies are insightful, they do not consider the impact of competitive interaction in an industry. Bulow, Geanakoplos, and Klemperer (1985), Sundaram, John, and John (1996), and other studies suggest that in situations of imperfect product markets, incomplete contracting, or incomplete information, strategic interaction can affect the outcomes of financial and investment choices. Sundaram et al. (1996) provide the first empirical evidence that the nature of competitive interaction in an industry has a significant impact on individual firms' share-price response to the announcement of R&D spending. (1) In this paper, we examine whether strategic interaction can also explain the wealth effects of new product announcements.

New product introductions can create opportunities for differentiation and competitive advantage, which can have a positive impact on the announcing firms' earnings and shareholder values. However, the actual impact depends on how the rival firms respond. If the rivals accommodate the announcers by staying put, then the expected impact on the announcers' profits and firm values will be positive and that on the rivals' will be negative. Bulow et al. (1985) describe this situation as competition in strategic substitutes.

On the other hand, if the rivals respond to the announcers' product launches by adopting a matching strategy, then the impact on the announcers' profits would be ambiguous. Although the product innovators can enjoy a temporary competitive advantage, they also incur costs in developing and introducing the new products that imitators do not bear (Mansfield, Schwartz, and Wagner, 1981). By imitating the innovators' actions, the rivals might reduce the competitive advantage enjoyed by the innovators and, thus, share in the profits (D'Aveni, 1994). …

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