Accepted Manuscript

Firm network structure and innovation

Tuugi Chuluun, Andrew Prevost, Arun Upadhyay

PII: S0929-1199(17)30182-7
DOI: doi: 10.1016/j.jcorpfin.2017.03.009
Reference: CORFIN 1174
To appear in: Journal of Corporate Finance
Received date: 9 March 2016
Revised date: 2 February 2017
Accepted date: 22 March 2017

Please cite this article as: Tuugi Chuluun, Andrew Prevost, Arun Upadhyay , Firm network
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 ACCEPTED MANUSCRIPT

Firm Network Structure and Innovation

Tuugi Chuluun*
Department of Finance
Sellinger School of Business and Management
Loyola University Maryland
4501 N. Charles Street, Baltimore, MD 21210
tchuluun@loyola.edu

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Andrew Prevost
Grossman School of Business

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University of Vermont
55 Colchester Avenue, Burlington, VT 05405
aprevost@bsad.uvm.edu

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Arun Upadhyay
Department of Finance
College of Business
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Florida International University
11200 S.W. 8th St, RB 247B, Miami, FL 33199
arun.upadhyay@fiu.edu
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November 2016
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Abstract

This study examines how various dimensions of a firm’s network affect innovation and pricing
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of innovation by market participants. We use board interlocks to build interfirm network and
construct different network measures to capture firm centrality in the interfirm network, cohesion
within firm network, and diversity, innovativeness, and propinquity of firm network. Our results
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show that these different characteristics of network connectedness affect firm innovation input
and output, particularly for firms in relatively intangible industries. These results are robust to
the use of an instrumental variables approach as well as a natural experiment of state-level
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changes in R&D tax credits. We also find that innovation has a positive (negative) marginal
effect on corporate bond yield spreads when firms have lower (higher) connectedness,
suggesting that the market perceives innovative activities by more connected firms as less
uncertain. Yield spread changes around patent filings further support this finding.

Keywords: network; connectedness; innovation; R&D; board interlock; bond yield

JEL classification: G30; G31; D80; L14

*Corresponding author. The authors would like to thank the participants of the 4th Annual CIRANO Workshop on
Networks in Trade and Finance for comments and suggestions. Tuugi Chuluun acknowledges financial support from
summer research grant from Sellinger School of Business and Management of Loyola University Maryland.
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1. Introduction

Innovation has long been considered one of the key determinants of firm value,

performance, and survival. Innovation involves the creation of more effective products and

processes with the application of new knowledge and information thus making information

essential for innovation development (Drucker, 1993; Hall, Jaffe and Trajtenberg, 2005). Social

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network theory suggests that a network of connections that a firm maintains can provide

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informational advantages and facilitate information diffusion. One such network is the interfirm

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network created through board interlocks. As firms form and maintain board interlocks, they

create a network of direct and indirect ties with each other. The structure of this interfirm

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network, in turn, can influence the dynamics of information diffusion among firms and affect
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various aspects of firm innovation, among others. In this paper, we investigate if characteristics

of firm network connectedness impact firm innovation and market participants’ perception of
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innovation risk. Specifically, we examine whether the structure of firm network affects firm
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R&D expenditures and patenting activities and if so, which structural properties enhance firm

innovation. We also examine whether the role of network connectedness varies depending on
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firm industry. Finally, we investigate whether network connectedness has a bearing on the
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pricing of innovation, using the yield spreads of newly-issued corporate debt and secondary-

market corporate bonds.

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In the corporate setting, directors serve an important advising function in addition to their

monitoring role. Boards advise on many strategic decisions such as the focus and general

direction of R&D expenditure, the approach to knowledge and intellectual property management,

and the level of investment in innovation. Many practitioner sources emphasize the role of board

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in innovation, especially in high-growth or entrepreneurial firms.1 Even in more established

firms, boards can help foster innovation. For example, Altria, Ford, Proctor & Gamble, Urban

Outfitters, American Express, NorthWestern Corporation among many others have innovation

and technology board committees charged with the oversight of, and guidance on, corporate

innovation strategy.2 Since knowledge and information are critical inputs to the board’s

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innovation advising function, the presence of directors that sit on multiple boards may be

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important as they help transmit tacit knowledge and information and expose firms to relevant

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information.

The implications of board connections and interlocks has been the focus of considerable

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academic research. One strand of this literature examines this subject from a corporate
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governance perspective and generally finds that board connectedness reduces the efficacy of

corporate governance (Barnea and Guedj, 2009; Liu, 2010; Hwang and Kim, 2012). Another line
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of work shows that director networks affect the flow of information and the level of
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communication between connected firms (Cai and Sevilir, 2012). In line with this latter view,

prior research finds that networks diffuse information and propagate certain corporate practices
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such as corporate finance policies (Fracassi, 2015), dividend policy (Bouwman and Xuan, 2010),
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private equity deal exposure (Stuart and Yim, 2010), and earnings management (Chiu, Teoh, and

Tian, 2013; Bouwman, 2011). Little research, however, has been conducted on how board
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networks affect innovation.

The social network literature suggests that repeated interactions among socially

networked individuals lead to elevated levels of mutual trust and trustworthiness (Glaeser et al.,

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Behan, B., “Innovation starts in the boardroom.” Directors and Boards, 39.1, 2014, p. 29; Useem, M., D. Carey and
R. Charan, 2014. “How boards can innovate.” Harvard Business Review (Digital Articles), May 21, pp. 2–4.
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Examples of charters of board innovation committees are available from http://us.pg.com/who-we-are/structure-
governance/corporate-governance/board-committees-charters and http://www.altria.com/About-Altria/Board-of-
Directors-and-Committees/Board-Committees/Innovation/Documents/Innovation-Committee-Charter.pdf.

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2000), which is an important element in information sharing among firms involved in

innovations. Helmers, Patnam and Rau (2015) use corporate governance reforms in India as an

exogenous shock to examine the effect of board interlocks on patenting and R&D spending

among publicly traded companies in India. Dasgupta, Zhang and Zhu (2015) study the effect of

prior social connections between managers or board members and supplier and customer firms

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on innovation of upstream firms. Dass, Kini, Nanda, Onal and Wang (2013) also focus on

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directors from related industries and examine their impact on firm performance. Alternatively,

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Kang et al. (2014) use CEO-director social connections as a measure of board friendliness to

investigate how ‘friendly’ boards affect firm innovation. Oh and Barker (2015) find that when

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CEOs serve as independent board members on other firms, they imitate the R&D intensity of
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firms they are interlocked with in their own firm’s R&D decisions. However, these prior studies

do not look at the various dimensions of network connectedness, which goes beyond
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documenting the existence of interlocks and describes a firm’s position within the broader
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interfirm network and the quality and structure of its immediate network.

Further, previous work has not explored if network connectedness affects the pricing of
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innovation risk by bond market participants. This is particularly interesting since the extant
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literature has found mixed results on the costs and benefits of innovation and hence how it is

priced. On one hand, a variety of work (e.g. Lev and Sougiannis, 1996; Eberhart, Maxwell and
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Siddique, 2004) finds a positive relation between R&D expenditure and stock returns. However,

additional work (e.g. Kothari, Laguerre and Leone, 2002; Shi, 2003) shows that R&D

expenditure increases cash flow variability suggesting that the benefit of R&D outlays may be

offset by the risk. Several recent studies examine how the relation between equity market

valuation and innovation may be conditional on factors such as managerial ability (Chen et al.,

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2015), size (Ciftci and Cready, 2011), and corporate governance (Chan et al., 2015) while others

point out misvaluation of innovation altogether (Cohen, Diether, and Malloy, 2013; Duqi, Jaafar

and Torluccio, 2015). Our use of corporate bond yield spreads allows us to examine if the

perceived impact of innovation activity on cash flow risk decreases for firms that are more

connected.

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To address these questions, we construct a set of network measures that capture a firm’s

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centrality in interfirm network (degree, eigenvector, and betweenness), cohesion and diversity

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within individual firm networks (density, network non-redundancy, and industry diversity), and

innovativeness and propinquity of firm networks (network innovativeness, industry propinquity,

geographic propinquity, innovative industry

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propinquity, and innovative geographic
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propinquity). Using these network measures, we assess if firm network characteristics impact

innovation input and output and we find that different dimensions of firm networks – centrality,
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diversity, innovativeness, and propinquity – affect innovation activities of firms while density
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does not. Moreover, our findings are strongest for firms in less tangible industries and robust to

the use of an instrumental variables approach as well as a natural experiment using state-level
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changes in R&D tax credits. We also find that network connectedness affects the pricing of
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innovation by bond market participants: innovation has a marginal positive (negative) effect on

yield spread when firms have lower (higher) connectedness, suggesting that the market perceives
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innovative activities by more connected firms as less uncertain. Additional tests based on yield

spread changes around patent filing dates provide further evidence of the role of connectedness

on the link between innovation and bond pricing.

Our work contributes to the board of director literature by showing how boards facilitate

information diffusion and, furthermore, contributes to our understanding of how innovation

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occurs in firms and how it is priced by the market participants. By documenting how different

aspects of firm network affect innovation, our paper also contributes to the growing literature on

the consequences of network connectedness on financial decision-making. A well-developed line

of research demonstrates that networks and their characteristics affect economic outcomes in

various settings (e.g., Kali and Reyes, 2010). In financial research, interest in social networks has

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only recently emerged. For instance, Cohen, Frazzini and Malloy (2008) focus on connections

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between fund managers and corporate board members via shared education networks. Hochberg,

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Ljungqvist and Lu (2007, 2010) examine networks in venture capital industry, and other studies

focus on the impact of informal networks on borrower terms (Garmaise and Moskowitz, 2003),

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mutual fund portfolio decisions (Fu and Gupta-Mukherjee, 2014), stock market participation
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(Hong, Kubik and Stein, 2004), and portfolio choice (Massa and Simonov, 2012).

The remainder of the paper is organized as follows. Section 2 discusses the relevant
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literature and describes our hypotheses. Section 3 discusses the various network measures in
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further detail. After describing the data and the descriptive statistics in Section 4, we

present the results on the relationship between firm networks and innovation input and output in
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Section 5. Section 6 presents the results on how firm network connectedness affects pricing of
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innovation. Section 7 concludes.

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2. Relevant Literature and Hypotheses

Network theory states that a firm’s network position determines, in part, the constraints

and opportunities that will be encountered by the firm which can affect information gathering,

strategic choices, corporate risk-taking, and utilization of scarce corporate resources; therefore,

network connectedness is important for predicting firm outcomes and performance. Firm

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network itself can vary along different dimensions. These different network characteristics

should have implications for the extent of trust, sharing, and cooperation that exist among

connected firms which in turn dictate the volume, diversity, and richness of information that

travel through network. Hence, firms with certain network capabilities have greater access to

valuable information that is relevant for firm innovation. To the extent that connectedness

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explains innovation, firm connectedness may also influence the value placed on innovation by

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market participants. In light of previous mixed findings on the costs and returns to innovation,

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this latter research question is particularly interesting.

Networks in general (Garmaise and Moskowitz, 2003) and of directors specifically

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(Khwaja and Mian, 2005) impact the availability of credit which is vital for firms engaged in
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innovative activities. Director networks could also impact the incentive system for top managers.

Firms need to have an appropriate level of financial incentives to encourage investments in long-
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gestational risky R&D intensive projects that risk-averse managers might not be willing to
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undertake. Directors coming from successful R&D intensive firms could play an important role

in designing suitable contracts that encourage top managers to invest in innovative projects. Such
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directors could also create an environment of risk-tolerance at the top that does not penalize
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failures related to innovation attempts and help other board members assess the riskiness and

overall value of innovative projects. Overall, boards can set the tone and direction at the top for
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innovation.

In this paper, we focus on board-level network centrality, density, diversity,

innovativeness, and propinquity. Both the quantity and quality of network ties may matter for

information diffusion and thus we expect some or all of the above network aspects to have a

potentially significant effect on the intensity of firm innovation. Among these various network

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characteristics, perhaps the most commonly studied is centrality which describes the location of a

firm in the global network using measures such as degree, eigenvector and betweenness. All else

being equal, firms with large networks receive a greater volume of information. Occupying a

bridging position and maintaining ties to well-connected partners would also imply a greater

access to a wide range of information that can be valuable for firm innovation policies.

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In addition to network centrality, cohesive networks of directors characterized by

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extensive interconnections may be associated with higher transmission capacity enabling large

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amounts of information and knowledge to rapidly diffuse and integrate. Dense networks may

also make firms more willing to cooperate and share relevant information as such networks give

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rise to trust, reciprocity, and shared identity (Coleman, 1988; Granovetter, 1992) particularly for
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innovation that requires generation of tacit information. Prior organizational research has shown

that the extent to which network cohesion affects information diffusion depends on the degree of
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tacitness of the information involved. Hansen (1999), for instance, shows that the transfer of tacit
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complex knowledge relevant to new product development is easier between frequent and close

connections because the motivation to assist a contact is greater than in infrequent and distant
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connections. Such cohesive and close relationships can be captured by measures like density.
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However, a highly cohesive network of directors may also mean that much of the shared

information and knowledge is homogenous and redundant originating from the same sources.
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Sociologists point out that cohesion can also mean adhering to established norms and standards,

which can stifle innovation and creativity.

Another aspect of network connectedness that relates to the information diffusion process

is diversity. A well-established body of management research and a newly emerging literature in

finance examine the impact of diversity on organizational performance with mixed findings on

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the nature of the relationship. On one hand, having a diverse network can make firms more

innovative because firms with heterogeneous networks may have better access to diverse

information pools. For example, in the context of CEO connectedness, Fang, Francis and Hasan

(2012) find that heterogeneity in the CEO’s social network is associated with higher market-to-

book ratio for firms, suggesting that diversity is considered a component of CEO social capital.

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On the other hand, relations based on similarity (or homogeneity) may be stronger due to easier

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coordination and communication and therefore affect the quality of information and the amount

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of cooperative effort shared between firms. Homophily refers to the principle that contact

between similar people occurs at a higher rate than among dissimilar people; patterns of

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homophily are consistent across different types of relationships such as marriage, friendship, and
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acquaintance (McPherson et al., 2001).

Recent research shows that relationships based on cohesion and diversity may not be
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opposites as previously assumed. For instance, Anderson et al. (2011) find that greater
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heterogeneity does not always improve board efficacy, and whether investors place valuation

premium or discount on board heterogeneity depends on the complexity of the firm.

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Furthermore, Reagans and Zuckerman (2001) find that both network diversity and density
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enhance R&D team productivity, while Phelps (2010) shows that density and diversity can

coexist and their benefits on firm innovation are complementary. Diversity that exists within
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individual firm networks can be measured by the extent of non-redundant ties (network non-

redundancy) or the extent of industry concentration in firm network (industry diversity).

Whether a firm is interlocked with innovative firms (network innovativeness) may be

relevant for innovation outcomes since several recent papers have shown that firms learn from

the experience of their partners and certain corporate practices spread through networks as

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evidenced by similarity across interlocked firms. Beckman and Haunschild (2002) show that

firms learn from the acquisition experiences of their network partners, and Fracassi (2015) finds

that more social connections two firms have, more similar they are in terms of their corporate

finance policies. Davis and Greve (1997) document that the practice of poison pill spread

through board-to-board diffusion process, and similarly, Bizjak, Lemmon and Whitby (2009)

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find that board interlocks helped spread option backdating. Stuart and Yim (2010) also show that

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firms with directors, who have experienced a private equity deal at another company, are more

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likely to become targets of private equity. Faleye et al. (2014) show that firms with CEOs that

maintain ties to individuals affiliated with innovative firms have higher R&D investment.

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Propinquity based on geography and industry may shed further light on how information
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relevant to innovation travels between firms. Information is more likely to be shared among

firms that are geographically close, and prior research has indeed documented the role of local
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networks in information exchange (e.g., Teo, 2009; Butler, 2008). We also surmise that
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information is more likely to be transferred among those who are in the same industry and that

industry-specific information may also be more relevant for innovation. Hence, we utilize the
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measures geographic propinquity and industry propinquity to examine these hypotheses and
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further interact these measures with network innovativeness.

We hypothesize that the impact of network connectedness on firm innovation is greater

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for certain types of firms. For example, the role of networks in innovation development may be

greater for firms in more intangible industries. We also examine if connectivity influences the

perceived value of innovation as reflected by the firm’s debt securities. Prior work (e.g. Lev and

Sougiannis, 1996; Eberhart, Maxwell and Siddique, 2004) finds a positive relation between R&D

expenditure and stock returns that may vary according to such factors as managerial ability

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(Chen et al., 2015), firm size (Ciftci and Cready, 2011), and corporate governance (Chan et al.,

2015) while further work demonstrates how innovation may be misvalued by the equity market

(Cohen, Diether and Malloy, 2013; Duqi, Jaafar and Torluccio, 2015). Additional work (e.g.

Kothari, Laguerre, and Leone, 2002; Shi, 2003) shows that R&D expenditure increases cash flow

variability suggesting that the benefit of R&D outlays may be offset by the risk. In particular, Shi

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(2003) uses the pricing of debt securities to show that R&D expenditure has a negative impact on

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the cost of debt as measured by bond ratings and risk premiums of at-issue bonds. However, Shi

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(2003) does not distinguish whether R&D expenditure increases firm value or whether the

increase in equity value documented in prior work results from a wealth transfer from

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bondholder claims. Eberhart, Maxwell and Siddique (2004) show that Shi’s (2003) results are
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sensitive to the measure of R&D expenditure and demonstrate that R&D has a positive net effect

on bondholder wealth. The effect is stronger for firms with greater default risk (i.e., firms with
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more to gain from R&D increases) and for firms where bondholders have greater covenant
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protection. Using patent portfolios, Hsu et al. (2015) find that firms' default probabilities, bond

issuance premiums, and realized excess returns are negatively related to the quantity and quality
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of firm patent portfolios. In a similar vein, Francis et al. (2012) show that borrowers with higher
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innovation capability enjoy lower bank-loan spreads and better nonprice-related loan terms.

We extend this line of work by examining how innovativeness, as measured by

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innovation input and output, impacts the cost of debt capital. In contrast to prior work, we

surmise that the effect is conditional on the extent of network connectedness. Based on the

premise that the information diffusion process is linked to the extent of the firm’s network, we

surmise that the degree of connectedness may impact the relation between innovation and credit

risk. Market participants may perceive networks to be an integral part of innovation and view

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R&D expenditure and other forms of innovative activity by firms that are relatively less

networked, or with lower network capabilities, as risk-increasing. Thus, innovation may have a

marginal positive effect on yield spread when firms are less connected, suggesting that the

market associates the impact of innovation as more uncertain when firms have less access to

information within the network.

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3. Network Measures

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We employ a set of network measures that describe the composition of a firm’s network

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and the firm's position within the broader interfirm network. Specifically, these network

measures capture a firm’s centrality in the interfirm network (degree, eigenvector, and

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betweenness), cohesion and diversity within the immediate network surrounding a firm (density,
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network non-redundancy, and industry diversity), and innovativeness and propinquity of firms

connected to a focal firm (network innovativeness, industry propinquity, geographic propinquity,

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innovative industry propinquity and innovative geographic propinquity). These network

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measures are computed using undirected binary data over four-year periods, and their

descriptions are provided in the Appendix.

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3.1. Centrality measures

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Perhaps the most commonly-used network measures gauge the centrality of a firm’s

position within the global network of firms. There are multiple centrality measures that approach
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centrality from different perspectives. Following prior research, we focus on three normalized

measures of network centrality. The simplest measure of centrality is degree, which is the

number of relationships a firm has. The higher the number of relationships a firm has, the more

access to information it has. We use a normalized degree measure, which refers to the percentage

of all other firms a specific firm is connected to during a period.

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Our second centrality measure is eigenvector (Bonacich, 1972), and it is similar to an

iterated degree measure. Essentially, eigenvector differs from degree in that not only how many

relationships a firm has, but also to whom it is connected matters. In other words, the centrality

of each firm is determined by the centralities of the firms it is connected to. We normalize this

measure by dividing it by the maximum possible eigenvector centrality in the network. Firms

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with higher eigenvector centrality are connected to others that are themselves well connected and

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become closer to all others in the interfirm network thus occupying more central positions at the

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center of the information hub.

Centrality can also be captured by the extent of bridging positions a firm occupies which

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enables a firm to serve as an intermediary, gatekeeper, or broker of valuable resources such as
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information. We use a betweenness measure proposed by Freeman (1979) that captures how

often a firm happens to be positioned on informational linkages between pairs of other firms. A
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firm is between two firms if it lies on the shortest possible path (i.e. geodesic distance) between
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them. We divide betweenness by the maximum possible betweenness in the network to obtain

normalized betweenness.
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3.2. Cohesion measure

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Density describes the level of cohesiveness or interconnectedness that exists within an

individual firm’s network. Specifically, density refers to the number of connections that exist
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among all partners of a firm divided by the maximum number of all connections that can

potentially exist among these partners. A densely connected network means that firms that are

interlocked to a specific focal firm maintain a large number of ties to each another indicating

more trust or coordination which can aid information diffusion.

3.3. Diversity measures

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Heterogeneity that exists within individual firm networks may indicate the types of

information channels that are present; as a result, heterogeneity can affect innovation either

positively or negatively. More heterogeneous networks represent more diverse information, but

connections based on similarity may instead be more reliable and informative. Firm network

heterogeneity is measured by the extent of non-redundant ties and the extent of industry

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concentration in a firm’s network here. The first diversity measure we examine is network non-

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redundancy which is based on the idea of structural holes developed by Burt (1992). A structural

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hole is a gap between two parties with complementary resources or information, and the premise

is that unconnected non-redundant ties are more likely to be diverse and offer different points of

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view. Network non-redundancy measures the proportion of a firm’s relationships to its partners
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that are considered non-redundant and referred to as effective size in the social network

literature. Specifically, it computes the number of partners minus the average degree of partners
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within the firm network, not counting ties to firm itself. If a firm is connected with others, who in
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turn are connected with the same firms, network non-redundancy measure will be low. Second,

industry diversity measures the industry concentration in a firm’s network using the Herfindahl
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index. For each firm, we compute the industry Herfindahl index based on the percentages of all
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interlocked firms in different Fama-French 30 industries. We use the inverse of the Herfindahl

index so that higher values are associated with greater diversity.

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3.4. Innovativeness measure

Since extant research documents that learning and information transmission occur in

networks (e.g., Beckman and Haunschild, 2002; Fracassi, 2015; Davis and Greve, 1997), having

ties to other innovative firms may affect a firm’s innovation policies. Hence, for each firm, we

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compute the number of all its interlocked firms that have positive R&D expenditure. We call

this measure network innovativeness.

3.5. Propinquity measures

Economic geography has long emphasized the importance of co-location and its role in

information and resource sharing (Sorenson and Stuart, 2001; Jaffe, Trajtenberg, and Henderson,

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1993). Prior finance research also documents the role of local networks in information exchange

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(Teo, 2009; Butler, 2008). Therefore, to shed further light on how information relevant to

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innovation travels between firms, for each firm, we compute the number of all its connected

firms that are located in the same metropolitan statistical area (MSA). We call this measure

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geographic propinquity. Information is also more likely to transfer among firms in the same
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industry. This is consistent with the principle of network homophily, which states that

information is likely to be shared among those who are similar: Birds of feather flock together
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(McPherson et al., 2001). In addition, industry-specific information may indeed be more relevant
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for innovation. Thus, for each firm, we compute the number of all its connected firms that are in

the same Fama-French 30 industry as the focal firm. We call this measure industry propinquity.3
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3.6. Innovative propinquity measures

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We refine the propinquity measures by interacting them with innovativeness: We capture

the number of all firms that a firm is connected to that are either in the same geographical
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location or industry as the firm and also innovative (i.e., have positive R&D expenditure). We

call these measures innovative industry propinquity and innovative geographic propinquity

measures.

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We also consider indirect connections and compute the number of directly and indirectly connected firms that are
either located in the same MSA or in the same industry. Indirect connections are those firms that a firm is connected
to through another firm. In other words, we are measuring the number of firms that are in the same geographical
location or industry within two degrees of separation. We find qualitatively similar results with these measures that
utilize two degrees of separation.

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4. Data

We obtain information on the directors of 3,838 unique firms in the S&P 1500 Index

from 1996 to 2013 from the RiskMetrics database. To examine how a firm’s position in its

interfirm network affects innovation, we map the entire network of these firms based on the

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interlocks between their boards. During the sample period, over 10,000 individuals served on the

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boards of the sample firms each year, and two firms are considered to have a board interlock

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whenever a director sits on the boards of both firms. We document the connections among all of

the firms over rolling four-year periods and find that all the firms are connected to at least one

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other firm during any four-year period. Using these board interlocks among firms, we compute
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network measures for each firm for each period. Some of the network measures are generated by

employing UCINET 6 software (Borgatti, Everett, and Freeman, 2002). For some network
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measures, we identify the MSA of a firm’s location using the firm headquarter location. The U.S.
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Census Bureau lists all the MSAs in the U.S. and their associated zip codes.

We match these network measures from rolling four-year periods to the financial data of
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the following year. We obtain various accounting data from the Compustat database for all the
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firms included in the S&P1500 universe. In line with previous research, we exclude firms in the

financial services and utilities industries. Our control variables include firm size (logged sales),
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market-book ratio (ratio of market value of assets to book value assets), sales growth, return on

assets (ROA), book leverage, cash holdings (scaled by total assets), the unionization rate

(described below), capital expenditure (scaled by total assets), and industry competition as

measured by the Herfindahl-Hirschman index. These control variables are winsorized at 1 and 99

percentiles to mitigate the effect of outliers and are further described in the Appendix.

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Prior research demonstrates that union strength affects risky decisions, including

innovation. For example, Chen, Kacperczyk and Ortiz-Molina (2011a) show that strong

organized labor curbs managerial incentives to take excessive risk, including risky investment

choices. More specifically, Betts, Odgers and Wilson (2001) demonstrate that industry

unionization rates and R&D expenditure are negatively correlated. We control for union strength

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with the percentage of unionized workers covered by bargaining agreements using industry-level

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unionization rates from the Union Membership and Coverage Database (www.unionstats.com)

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maintained by Barry Hirsch and David Macpherson. Unionization rates are reported at the

Census Industry Classification (CIC) level, which we merge to firms in our sample by converting

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to the corresponding 4-digit SIC code. A variety of studies (e.g. Klasa, Maxwell and Ortiz-
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Molina, 2009; Chen, Kacperczyk and Ortiz-Molina (2011a, 2011b); Chen, Chen and Liao, 2011)

provide evidence that industry-level unionization rates effectively proxy for firm-level rates.
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With respect to innovation input, our primary variable of interest is R&D intensity,
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measured as the ratio of R&D expenditure to total assets; following the conventional approach,

we set R&D to zero when it is missing. To measure firm innovation output, we use NBER patent
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data that was originally constructed by Hall, Jaffe and Trajtenberg (2001).4 The first measure of
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innovation output is the number of patents a firm applied for in a given year. Next, we consider

the type of patents. In the innovation literature, patents can be categorized into exploitative vs.
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exploratory innovation (e.g., Gilsing et al., 2008). A patent is considered exploitative if it is in an

area that an organization innovated before and, hence, deepens an organization’s existing

knowledge base. Exploratory innovation, on the other hand, broadens an organization’s existing

knowledge base and involves a patent in an area that is novel to the organization. It is possible

4
The data is obtained from https://sites.google.com/site/patentdataproject/Home. The patent data is only available
until 2006. Thus, our analysis on innovation output is for a shorter time period than that on innovation input which
utilizes accounting statement data.

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that network plays an even greater role in bringing novel information that results in exploratory

innovation rather than exploitative innovation that derives from existing knowledge base. Hence,

for each firm, we make a list of all the technology classes in which the firm had filed patents in

the previous five years and then compare whether a patent applied in a given year is in a new

technology class compared to the previous years to determine whether a patent is exploratory or

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not. Then we count the total number of exploratory patents a firm applied for in a specific year.

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We also measure patent diversity using the inverse of the Herfindahl Index based on patents a

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firm filed in a given year in different technology classes. To further quantify the impact and

significance of patents, we utilize the total and average number of subsequent citations a firm’s

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patents receive. One issue with using citations data is the truncation bias due to the finite length
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of the sample period. To address this issue, we use the weighting index developed by Hall, Jaffe

and Trajtenberg (2005).

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We explore if network connectedness influences the risk of innovation perceived by

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market participants by using the pricing of at-issue corporate bonds obtained from the SDC

Platinum database. We exclude convertibles, bonds for which there is no conventional yield to
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maturity (e.g. floating and step-up coupon bonds), and bonds with synthetic features and exotic
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structures. We obtain at-issue yield to maturity, security type, embedded options, coupon rate

and proceeds amount from SDC. In subsequent analyses, we examine changes in yield spread
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following patent filing dates obtained from the NBER patent database. We obtain secondary

market transactions using corporate bond price data obtained from the TRACE and Mergent

FISD databases. We provide further details about these sources below.

Table 1 Panel A presents summary statistics of our network measures. Mean degree

centrality over all periods is 0.31 percent; eigenvector is 2.12; and betweenness is 0.024. The

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mean density of firm networks is 15.33 percent. As for the diversity measures, the mean network

non-redundancy is 3.69 and industry diversity measure is 4.39, which is the inverse of

Herfindahl index based on the percentages of a firm’s partners in different industries. On

average, a given firm is connected to 3.36 other innovative firms with positive R&D spending.

As for similarity in location (industry), on average, a firm is directly connected to 1.14 (0.82)

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other firms located in the same MSA (industry). On average, a firm is also connected to 0.52

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(0.55) other firms with positive R&D spending that are located in the same MSA (industry).

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Panel B presents the descriptive statistics of the innovation measures and remaining firm-

level control variables. R&D intensity has a mean of 0.036 with many firms having no R&D

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expenditures. The average number of patents is 16.67. The average number of exploratory
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patents is 0.71, and the average patent diversity measure is 4.29. On average, patents receive

130.88 citations. Firms have mean sales of 5.6 billion dollars. Market-book ratio (defined as the
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ratio of market value of assets to book value assets) gauges expected growth and has a mean of
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1.92. Sales growth has a mean of 0.096. Book leverage and ROA have a mean of 0.22 and 0.03,

respectively, and the average for cash holdings is 0.11. The unionization rate, on average, is 9.27
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percent. Average industry HHI is 0.282. In additional robustness tests, we control for CEO
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network size, analyst estimates, and institutional ownership. Descriptive statistics for these

variables are presented in Table 1 Panel B.

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5. Network Connectedness and Innovation Input and Output

5.1. Single equation least squares estimates

We examine if firm network characteristics affect innovation input and output,

particularly for firms in industries that rely more on intangible assets. Table 2 presents our results

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of firm network structure and R&D intensity. We estimate a regression on R&D intensity using

firm network variables along with standard control variables. Since the three centrality measures

are highly correlated, we find that the first principal component obtained from principal

component analysis explains most of the variation in the three measures. Thus, centrality is a

composite measure of three network centrality measures that capture network size (i.e., degree),

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closeness (i.e., eigenvector), and extent of bridging intermediary positions (i.e., betweenness)

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based on their first principal component. In a similar manner, we report one measure from each

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category of network variables. For example, since the results of the two diversity measures,

network non-redundancy and industry diversity, are qualitatively similar we report results using

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only industry diversity. We also report results using only geographic propinquity and innovative
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geographic propinquity. All the regressions include year and (Fama-French 30) industry fixed

effects and the standard errors are clustered at the firm level.
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In Table 2 Panel A, the estimated coefficients on all the network variables except for
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network density are significant in Models (1)-(6). As the coefficient on the centrality measure in

Model (1) shows, the more centrally located firm i is in the interfirm network, the higher the
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R&D intensity: this is consistent with the premise that greater network centrality is more
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conducive for information diffusion. Firms that are connected to other firms in more diverse

industries also tend to spend more on R&D as Model (3) shows. As evidenced by the coefficient
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estimate of the innovativeness measure in Model (4), firms that maintain ties to innovative firms

also spend more on R&D. This is consistent with the previously documented transmission

capacity of networks. Certain corporate practices and policies are known to propagate via firm

networks (Fracassi, 2015; Bouwman and Xuan, 2010; Bouwman, 2011). The positive and

significant coefficient on geographic propinquity in Model (5) shows that firms that maintain a

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higher number ties to other firms located in the same geographical area also have higher R&D

intensity.5 This suggests that physical proximity promotes information sharing that leads to more

R&D activities. Ties to other co-located firms that also happen to be innovative are even more

important as evidenced by the significant coefficient in Model (6) that is larger than the

coefficient in Model (5). The level of network density, however, is not significant as shown in

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Model (2). This suggests that when it comes to innovation input, how cohesive or tight knit a

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firm’s network is does not matter. The signs and significance of the remaining control variables

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are in line with previous findings. Consistent with the results documented by Hirschleifer, Low

and Teoh (2012), we find that higher R&D expenditures are associated with smaller firms. R&D

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spending is also correlated with higher growth, as evidenced by the positive coefficient estimates
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for market-book ratio and prior sales growth. Also consistent with Hirschleifer et al. (2012),

R&D spending is associated with poorer operating performance, lower book leverage, and higher
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cash holdings. Consistent with past findings that demonstrate a negative relation between union
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presence and R&D expenditure, unionization rate is negative and significant at the 1 percent

level. Firms with higher levels of capital expenditure invest less in R&D, and the negative and
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significant coefficient on industry HHI suggests that firms in more competitive industries tend to
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invest more in R&D.

Next, we re-estimate these regressions in subsamples of firms in tangible and intangible

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industries as we believe the role of networks in innovation development may be greater for firms

in more intangible industries. We define tangibility as the ratio of property, plants, and

equipment to lagged total assets and compute industry average tangibility. We further divide

industries into those above and below the median industry tangibility. The results in Table 2B are

5
The results remain qualitatively the same when we use propinquity measures based on both direct and indirect
connections (i.e., two degrees of separation).

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consistent with this premise: The estimated coefficients for firms in intangible industries are

typically significant and larger than those obtained for the firms in the tangible industries

subsample. This demonstrates that network has a greater impact on innovation input for firms in

intangible industries.

These results demonstrate that network centrality, diversity, innovativeness, and

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propinquity matter for R&D intensity, and the impact of network on R&D intensity depends on

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firm characteristics. Our findings are also economically significant. For example, one standard

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deviation change in the composite measure of centrality (innovativeness) is associated with

0.0044 (0.010) increase in R&D intensity in the full sample, where the median R&D intensity is

zero and mean is 0.036.

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We now turn to whether network connectedness affects the level and type of innovation

output using patent data. The results in Table 3 Panel A show that all network characteristics,
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except for density, have statistically significant coefficients. Therefore, higher centrality is
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associated with higher number of patents which is consistent with more information diffusion

being conducive for innovation. In addition, firms that maintain ties to other firms that are
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innovative, geographically close, or in diverse industries file more patents. This is again
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consistent with the previously documented transmission capacity of networks.

In Panel 3B, we focus on the extent of exploratory patents, which specifically capture
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innovation in new fields for the filing firm. The results are similar to those obtained from Panel

3A in that all the network variables, except for density, are significant and positive. In Panel 3C,

we examine the diversity of patent classes and find that firms that maintain diverse or innovative

networks, in turn, innovate in a broad range of technology classes. This suggests that firms use

their networks to generate information, and those firms with diverse and innovative networks

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receive diverse information leading to the creation of diverse innovation. When we re-estimate

these patent regressions in subsamples of firms in tangible and intangible industries in Panels

4D1-4D3, distinct differences emerge in the results across the subsamples. In general, the

network variables are significant and have larger estimated coefficients for firms in intangible

industries compared to those for firms in tangible industries. Thus, network connectedness and

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its information capacity matter more for patents filed by firms in relatively intangible industries.

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Next, we examine innovation output in terms of patent impact using number of citations.

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As the results in Table 4 Panel A show, all the network characteristics, except for density,

significantly explain the number of citations that firms’ patents receive. Hence, firms with more

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central, diverse, innovative, and geographically proximate networks file more impactful patents
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that subsequently receive more citations. We also compute the average number of citations by

dividing the number of citations by the number of patents and repeat our analysis in Table 4
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Panel B, which produces qualitatively similar results. We also test whether these results vary
ED

across industry subsamples and find similar results to those in Table 3 subsamples. For the sake

of brevity, these results are not reported in the paper but available from the authors.
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To add further insight on the mechanism of networks, in an unreported regression we

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estimate the likelihood of a firm filing an exploratory patent in a specific technology class given

the number of patents already filed in that class by its connected firms. For each firm, we count
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the number of patents its connected firms filed in each technology class during the previous five

years and estimate a logit model using this measure and additional control variables. Consistent

with the view that board connections facilitate information transmission, the (untabulated) results

show that a higher number of patents filed in a specific patent class by interlocked firms

increases the likelihood of a firm filing an exploratory patent in that patent class; firms are more

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likely to innovate in an area, where their interlocked firms have already engaged in innovation

activity.

Overall, we see that network centrality, diversity, innovativeness, and propinquity affect

innovation output as measured by number and type of patents and citations, and the effect is

pronounced for intangible asset-intensive firms. Network density, on the other hand, proves to be

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largely insignificant in the context of innovation input and output. This shows how the different

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dimensions of network connectedness can have different information roles. As for economic

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significance, for example, a one standard deviation change in the composite measure of

centrality is associated with 0.11 increase in logged number of patents in the full sample.

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Similarly, one standard deviation changes in network diversity and innovativeness are associated
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with 0.141 and 0.159 increases in logged number of patents, respectively.

5.2. Tests of robustness

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We examine the robustness of the results discussed in the previous section first by
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controlling for additional explanatory variables. The first variable is the extent of the CEO’s

network. Several prior studies have shown how CEO network affects executive compensation
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(Engelberg et al., 2013), mergers and acquisitions (El-Khatib et al., 2015; Chikh and Filbien,
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2011), corporate fraud (Khanna et al., 2015), country financial development (Ferris et al., 2016),

and firm value (Fang et al., 2012). We view board and CEO networks as complementary
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information channels, not as substitutes. Hence, we test whether board networks explain

innovation independent of the role of CEO network. We use a CEO network measure from the

Boardex database that measures the number of individuals a CEO overlapped with through

employment, education, and other activities. This variable, therefore, measures the number of

external connections that CEO builds over time. It is, however, available only for a subset of the

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firms included in our sample. We also control for institutional ownership and analyst coverage

and re-estimate the regressions from Tables 2-4 with these three additional variables. We find

that the extent of institutional ownership and analyst coverage are largely not significant, but the

CEO network measure is significant and positive for R&D intensity. For patent and citation

measures, CEO network is occasionally negative, but largely insignificant. In these untabulated

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regressions, analyst coverage (institutional ownership) is occasionally positive (negative) and

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largely insignificant. However, the results of the board network variables remain significant and

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qualitatively similar, which shows that board and CEO networks represent two different channels

of information. For brevity, we do not report these results as they are based on a much smaller

sample and do not change our main results.6

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While the previous section establishes correlation between board network and innovation

output, there is also a possibility that potential endogeneity between connectedness and the
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dependent variables may be biasing the results. To ensure that our results are robust to the
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possible simultaneous determination of connectedness and innovation, we re-examine our

primary results in Table 2 using a two-stage least squares (2SLS) approach in Table 5, specifying
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the network measure in each respective column as endogenous. Following the approach of
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Chuluun, Prevost and Puthenpurackal (2014), who identify effective instruments for board

centrality based on distance from other firms and location, the first instrument is the logged
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number of other public firms that are situated in clustered networks of cities (i.e., megaregions).

We define the megaregion of each firm’s headquarters using six U.S. megalopolis regions

(Arizona Sun Corridor, California, Cascadia, Great Lakes, Northeast megalopolis, and Piedmont

Atlantic Megaregion) and obtain the number of publicly listed companies headquartered in each

region using the LexisNexis database. The second instrument is the logged average distance
6
These results are available upon request from the authors.

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between the firm’s headquarters and other firms within its Census region, and is constructed

using location information from the U.S. Census Gazetteer files and the states belonging to each

of the nine regions defined by the U.S. Census.7

In Panel 5A, we report the first-stage coefficient estimates for the two instruments (for

brevity we do not tabulate the estimates for the additional second-stage regressors). Logged

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public companies is positively related to the network measures as expected and is statistically

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significant in five of the six models. Logged distance is negatively, albeit insignificantly, related

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to connectedness for most of the models. In Panel 5B, we present the second stage estimates. The

instrumental variables for the network measures remain positive and statistically significant

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except for density in Model (2). The Kleibergen-Paap LM Statistic tests the null hypothesis that
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the model is underidentified: except for Model (2), the test statistics are significant at the 1

percent levels indicating that the models are not underidentified. In the last row, the Hansen J
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statistic tests the null hypothesis that the overidentification restrictions are valid. For Models (1)-
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(6), the J statistic p-values are above 0.80, indicating that the null cannot be rejected and that the

instruments are appropriate and well identified in each model.

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To further establish that our primary results are free from endogeneity biases, we identify
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a natural experiment using state-level increases in tax incentives (credits) associated with

corporate R&D expenditure. The question of whether state R&D credits affect private R&D
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spending is explored by Wilson (2009), who provides state-level R&D tax credit rate changes

implemented over the 1992-2006 period. In our context, we use increases in state R&D credits as

a natural experiment to test if innovation spending motivated by higher tax credits varies

according to the level of firm connectedness. To the extent that network centrality facilitates

7
See Chuluun et al. (2014) for further details about the construction of these two measures.

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innovation, we expect to find that the innovation response to higher R&D tax credits should be

increasing in the extent of ties to other firms.

Using data from Daniel Wilson’s website, there are 14 states that increased R&D tax

credits during 2000-2006.8 Table 6 Panel A lists these states and the corresponding percentage

increases in the tax credit. Using the firms in our sample that were incorporated in these states as

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of the year of the tax credit increase as the treated sample, we identify one matched control firm

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from a non-tax credit change state based on industry (Fama-French 30) and size (closest sales

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within plus / minus 30 percent of the sample firm’s sales) for each sample firm. Similar to

Goldman and Peress (2016), we exclude firms incorporated in Delaware from the pool of

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potential control firms because many firms locate in Delaware for reasons unrelated to their
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operations. Using each treated firm and its matched firm counterpart, we construct a three-year

panel consisting of one year prior to one year after the credit increase year and create a binary
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variable (tax credit increase) equal to one for firms incorporated in states with tax credit
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increases and zero for matched firms in states with no increase. To test the effect of tax credit

increases on innovation spending, we create a dummy variable equal to one (zero) for the year
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following implementation (post) and estimate the following regression model:

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R & D Intensity  α0  α1Tax credit increase  α2 Post  α3Tax credit increase  Post  Year fixed effects  e j,t (1)

The coefficient estimate α3 measures the net difference in R&D intensity for firms in
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states with credit increase in the year following the increase relative to matched firms. In

addition, we include year fixed effects in Equation (2). The results of the differences-in

differences estimation are presented in Table 6 Panel B. As indicated in Model (1), the primary

sample of treated and matched firms is 460 firm-years. Model (1) illustrates that α3 is positive,

8
http://www.frbsf.org/economic-research/economists/daniel-wilson

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but not significantly different from zero for the full sample. However, if network connectedness

facilitates innovation activities, then more connected firms should have the strongest initial

response to an exogenous increase in the incentive to innovate; the effect should be reflected by a

positive α3 coefficient estimate. To test if the ability to innovate is conditional on the degree of

connectedness, we sort the full sample and create subsets based on centrality terciles and re-

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estimate Model (1) for each subset. The results in Models (2)-(3) support this premise: the α3

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interaction coefficient estimate is positive and significant at the 5 percent level for the highest

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tercile centrality firms and not significant for the lower two terciles, suggesting that board

connectedness plays a role in innovation decisions.

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6. Innovation, Firm Connectedness, and the Pricing of Corporate Debt Securities

Our primary findings connote that information transmission associated with network
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connections reduces uncertainty surrounding innovation. Thus, we surmise that innovation has
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varying effects on the pricing of debt securities according to the level of firm connectedness.

However, an alternative explanation is that more connected boards may be ‘busier’ with less
PT

time to monitor managers (e.g. Faleye, Hoitash and Hoitash, 2011) which, in turn, may result in
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greater managerial risk taking including innovation activity.9 To distinguish between these views

and to add insight to the prior findings of Shi (2005) and Eberhart, Maxwell and Siddique (2004)
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who also study the association between innovation and bond pricing, we use a broad sample of

at-issue yield spreads obtained from the SDC Platinum database to examine if the extent of

network changes the perceived impact of innovation on cash flow risk. Unlike expected stock

return, yield-to-maturity is a deterministic measure of return that has well-defined risk premium

components related to default, liquidity, and information. Using the at-issue yield-to-maturity
9
We thank our reviewer for suggesting this alternative explanation.

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obtained from SDC and constant-maturity Treasury bond indices obtained from the Federal

Reserve of St. Louis Economic Data (FRED), we calculate the at-issue credit yield spread for

each bond by subtracting the yield-to-maturity for the same time to maturity on the Treasury

yield curve using linear interpolation.10

We base our analysis on the broad centrality measure described above. We begin by

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regressing at-issue yield spreads on the innovation input and output measures (R&D intensity,

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logged number of patents, and logged number of citations), the composite board centrality

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measure, and independent variables that control for additional bond- and firm-level

characteristics likely to be related to the risk premium on corporate bonds. The cross-sectional

model is specified as follows:

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AN
Yield spread  α0  α1 Innovation measure  α2Centrality  α3 Residual bond rating  α4Callable
 α5 Putable  α6 Coupon rate  α7Time - to - maturity   8 Log(Issue amount)  α9 Baa  Aaa spread (2)
 10Log(No. estimates)  α11Tobin' s q  12Sales growth  α13ROA  α14 Std. ROA  α15 Book leverage
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 α16 Firm size  Fama - French 30 industry fixed effects  Year fixed effects  e j,t
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Credit ratings are determined by variables that are also used to explain yield spreads; thus, to

discern the impact these variables have on yield spreads independent of their effect on credit
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ratings, we follow Mansi, Maxwell and Miller (2004) by creating a residual bond rating variable
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that is purged of the information contained in the bond- and firm-specific control variables.

Residual bond rating is the residual of a regression of Moody’s bond ratings (converted to
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numerical equivalents ranging from 1 (“C”) to 21 (“Aaa”)) on the right side variables specified

in Equation (2) and provides an overall measure of default risk independent of the direct effects

the additional control variables may have on bond ratings.

10
FRED provides daily yields to maturity for constant maturity Treasury bond indices for 3-month, 6-month, 1-year,
2-year, 3-year, 5-year, 7-year, 10-year, and 20-year, and 30-year maturities.

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In addition to the board centrality measure, the additional control variables are drawn

from a large body of work on the determinants of yield spreads (e.g. Mansi,

Maxwell and Miller, 2011; Ortiz-Molina, 2006; Klock, Mansi and Maxwell, 2005; Bhojraj and

Sengupta, 2003). The binary variables callable and putable control for embedded call and put

options, respectively. Time to maturity controls for the effects of bond term on yield spread and

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coupon rate controls for positive coupon effects documented in prior work (e.g. Campbell and

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Taksler, 2003). Logged issue amount controls for liquidity: Larger issues are associated with

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economies of scale in underwriting and reduction in liquidity risk (Bhojraj and Sengupta, 2003).

Exposure to systematic fluctuations in credit spreads are captured by Baa-Aaa spread; we obtain

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monthly values of the seasoned Moody’s Baa and Aaa corporate bond yield indices from the St.
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Louis Fed economic data repository (FRED). With respect to the firm-level explanatory

variables, we control for analyst coverage and the quality of the information environment
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surrounding the firm with Logged No. Analyst estimates. Market-book ratio (sales growth) gauge
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expected (realized) growth, respectively. Profitability is measured with ROA, while Std. (ROA)

measures cash flow risk. Book leverage is an alternative gauge of proximity to default. Finally,
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following the analysis above, we use logged sales to control for firm size. We control for
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unobservable effects related to industry and time by including Fama-French 30 industry and year

indicator variables.
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Table 7 provides summary statistics for the at-issue sample and the control variables used

in the regression models. There are 2,769 at-issue yield spread observations with non-missing

values of the centrality measure and additional control variables used in Equation (2).

Approximately two-thirds of the sample bonds contain call provisions and a small minority

contain put provisions. About 37 percent of bonds are rated at the Baa level, the most common

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rating category within the sample. The typical (median) bond has a yield-to-maturity (yield

spread) of 5.37 (1.62) percent, has an original maturity of about 10 years, and has an issue size of

approximately $750 million. Descriptive statistics for the innovation measures are provided in

Panel C. R&D intensity has a mean of 0.0202. In Panel C, there are 15 analysts following the

typical firm. The typical (median) market-book ratio is 1.56 with five-year sales growth of about

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6 percent. ROA (Std. ROA) is 6.07 percent (2.16 percent), the leverage ratio of 29 percent, and

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sales is 11,067 ($Mil.)

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In Table 8, we estimate Equation (2) over centrality subsets, using the first two terciles to

represent firms with low to moderate levels and the top tercile to represent high levels of network

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connectedness. In Models (1)-(2) using R&D intensity, innovation input is positive albeit not
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significantly related to yield spread within the lowest two terciles. However, R&D intensity

becomes negatively and highly significant (p=0.00) in the top tercile, suggesting that network
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centrality reduces bondholder perceptions of risk associated with innovation input. In Models
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(3)-(4), we estimate Equation (2) using logged number of patents as the measure of

innovativeness. Consistent with the R&D intensity coefficient estimate in Model (1), number of
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patents is positive and significant at the 5 percent level in the low-to-mid category of centrality.
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In contrast, number of patents becomes negative and statistically significant at the 10 percent

level when board centrality is in the top tercile of the sample, indicating that the perception of
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risk surrounding innovation output decreases when firms have greater centrality. Finally, we

repeat these regressions using logged number of citations in Models (5)-(6). Similar to our

findings using R&D intensity and number of patents, number of citations is positive and

significant at the 5 percent level for centrality terciles 1-2 and significantly negative at the 5

percent level in the top tercile. Viewed collectively, these results support the premise that bond

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market participants have sharply different views of the risk consequences of innovation when

firms are more (less) central: Lower centrality implies greater risk and more uncertain output to

innovative activity, while higher centrality lowers the perceived risk and reduces uncertainty

about the effects of innovation.11

The results of Table 8 are potentially subject to endogeneity bias due to the joint

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determination of yield spread and innovation activity. As a test of robustness, we examine

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changes in yield spreads around news of innovation output using secondary bond market

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transactions. We obtain corporate bond transactions data from TRACE (Trade Reporting and

Compliance Engine) and Mergent FISD (Fixed Income Securities Database). The TRACE

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database begins in 2002 and includes the time of execution, price, yield to maturity, and trade
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volume. The Mergent FISD database consists of pricing (buy and sell) information by life

insurance companies from the National Association of Insurance Commissioners (NAIC). To

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maximize the number of bonds used in the analysis, we combine the two databases and eliminate
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any duplicate transactions. For each day, we aggregate multiple buy and/or transactions into a

daily yield to maturity using the par amount of each transaction as weights. Following the
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process described above, we estimate a yield spread by subtracting the interpolated constant
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maturity Treasury curve.

To measure the effect of innovation output on bond prices, we examine changes in yield
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spread around patent filing dates from the NBER patent database. Specifically, we select patents

with no other patent grants from the same firm within 90 days before and after. To the extent that

the event is unanticipated by the market, the change in the yield spread following the filing

11
Alternatively, we estimated three models using the full sample that include interactions between each respective
innovation measure and firm network centrality. The interaction coefficient estimate measures the amount of change
in the slope of the regression of yield spread on the innovation measure when centrality changes by one unit. The
coefficient estimates for all three interactions are negative and significant at the 5 percent levels or lower.

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reflects the response of bond market participants to an exogenous change in innovation output.12

Our basic methodology is to identify the closest transaction date prior to- and following the filing

date for bonds that have at least one transaction within the 30-day period before- and following

the filing. To estimate the pricing impact of the filing, we subtract the post-filing- from the pre-

filing yield spread. We aggregate multiple changes in bond yield spreads for a given issuer to a

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weighted average firm basis using the offering amount of each bond as weights. Table 9 Panel A

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provides characteristics of the resulting sample, including weighted average yield spreads prior

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to- and following the filings, total par amounts transacted on the pre- and post-filing dates, and

the proximity of the transaction dates to the filing date, and characteristics of the bonds in the

analysis (years to maturity, rating, and years from issuance).

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Table 9 Panel B illustrates reactions of bond prices to patent filings conditioned on

connectedness. To minimize the influence of outlying yield spread observations, we winsorize

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the distribution at the 2.5 percent tails. We follow the analyses above by creating centrality
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terciles based on the year of the filing. Overall, we find that yield spreads decrease by

approximately 13 basis points following the filing. In support of our earlier cross-sectional
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findings using the at-issue sample, Panel B demonstrates that this effect is primarily driven by
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top-tercile centrality issuers: for firms in this subset, the mean (median) yield spread decreases

by 25 basis points (24 basis points) following the filing, compared to a reduction of 6 basis
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points (7 basis points) for the lower two terciles. In sum, these results continue to support the

interpretation that the advising services and other resources provided by connected directors help

reduce the perceived risk of innovation by outside market participants, resulting in a lower risk

premium demanded on the firm’s debt securities.

12
Since filing a patent with the U.S. Patent and Trademark Office is public news, we use filing dates as
announcement dates. It is possible that a filing of a specific patent is anticipated by the market, but this will only
bias our results in the opposite direction.

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Prior research provides a theoretical rationale (e.g. Duffie and Lando, 2001) and

empirical evidence (e.g. Yu, 2005; Lu, Chen and Liao, 2010) for the premise that yield spread

becomes more sensitive to information uncertainty as bond maturity decreases. Accordingly, in

Table 9 Panel C we examine if yield spread changes are pronounced for short-maturity bonds by

disaggregating the firm-level changes in yield spread to the bond-level; we regress these changes

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in bond yield spreads on the centrality measure, a binary variable for short-maturity debt, an

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interaction between centrality and the maturity indicator, and additional control variables for

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credit rating (bond rating), bond liquidity (logged bond age and the combined amount of bonds

transacted on the yield spread transaction dates), the closeness in days that the two transaction

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dates are to the patent filing date, and firm size. The centrality × maturity less than 5y interaction
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is significant at the 10 percent level. Furthermore, reducing the maturity to 3 years or less

intensifies the magnitude and the significance of the interaction’s coefficient estimate
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approximately twice (to 5 percent), respectively. Overall, these results provide further support
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for the intuition that greater network centrality allows market participants to better discern the

impact of innovation output on the risk premia of information-sensitive debt.

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7. Conclusions

In this study, we examine if network connectedness affects firm innovation and the value
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placed on innovation by market participants. Specifically, we investigate whether the various

dimensions of a firm’s network affect firms’ R&D expenditures and patenting activities, and if

so, what structural properties enhance firm innovation. Furthermore, we also examine whether

the role of network varies depending on firm industry. In addition, we investigate if firm network

affects the pricing of innovation by bond market participants.

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We use board interlocks to create interfirm networks. As firms form and maintain board

interlocks, they create a network of direct and indirect ties with each other. This network, in turn,

can influence the dynamics of information diffusion among firms and affect firm innovation

since information is integral to the innovation process. To answer these questions, we construct a

set of network measures that capture network centrality, density, diversity, innovativeness, and

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propinquity. We find that these different dimensions of firm network – centrality, diversity,

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innovativeness, and propinquity – indeed affect innovation activities of firms, especially for

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those firms in less tangible industries. Firms that have more extensive and central networks and

connected to other innovative firms, firms in more diverse industries, or local firms are

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associated with higher innovation input and output. However, density (i.e., cohesiveness) of a
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firm’s network does not matter in this context of innovation input and output supporting the view

that cohesive networks can have homogenous and redundant information which may not be
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relevant for innovation. The above results are robust to the use of an instrumental variables
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approach and a natural experiment of state-level changes in R&D tax incentives as well as

additional control variables including CEO network.

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We also find that firm network affects pricing of innovation by bond market participants:
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innovation has a marginal positive (negative) effect on yield spread when firms have lower

(higher) connectedness, suggesting that the market perceives innovative activities by less
AC

connected firms as more uncertain and hence, risk-increasing. Further tests on bond yield spread

changes surrounding patent filings support these results. By documenting how different aspects

of firm network affect innovation, our paper contributes to the growing literature on networks in

finance. This work is also relevant to the board of director literature by showing how boards aid

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information diffusion and contributes to our understanding of how innovation occurs and is

priced by the market participants.

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Appendix 1: Variable description

Firm network measures

xj
ij
Degree Percent of all other firms a specific firm is connected to. Specifically, Degree i  , where xij equals
n 1
to one when there is a tie between firms i and j, and n equals to the number of all firms in the network.
Eigenvector Eigenvector centrality captures how close a firm is to all other firms by taking into account the eigenvector
centralities of the interlocked firms. Formally, ei  x e
j
ij j , where λ is a proportionality constant, and

xij equals to one when there is a link between firms i and j, and we normalize this measure by dividing it by

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the maximum possible eigenvector centrality in the network.
It measures how often a firm falls on the shortest possible paths between pairs of other firms.

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Betweenness
Betweennes si  b
jk
jik , where bjik is the proportion of all paths linking distinct firms j and k that pass

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through firm i, and we divide it by the maximum possible betweenness in the network to obtain normalized
betweenness.
Density The percent of all possible connections that can exist among the interlocked firms of a firm that are actually

x jk

Network non-redundancy
Industry diversity
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jk
present. Densityi  , where xjk equals to one when there is a link between firms j and k with
ni (ni  1)
whom firm i is connected to, and ni equals to the number of all firms interlocked to a firm i (i.e., degree of
firm i).
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The proportion of a firm’s relationships to its partners that are considered non-redundant, calculated as the
number of partners minus the average degree of partners within the firm network, not counting ties to the
focal firm itself.
(Inverse of the) Herfindahl index computed using the percentage of interlocked firms in different Fama-
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French 30 industries. 𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦. 𝑑𝑖𝑣𝑒𝑟𝑠𝑖𝑡𝑦𝑖 = 1/ ∑𝑁 2

Network innovativeness
Geographic propinquity
𝑚=1 𝑠𝑚 where sm refers to the percentage of all partners
of firm i in industry m.
Logged number of all interlocked firms with positive R&D expenditure.
Logged number of all interlocked firms located in the same metropolitan statistical area (MSA) as the firm.
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Industry propinquity
Innovative geographic propinquity
Innovative industry propinquity
Logged number of all interlocked firms that are in the same Fama-French 30 industry as the firm.
Logged number of all interlocked firms located in the same MSA as the firm and also have positive R&D
expenditure.
Logged number of all interlocked firms that are in the same Fama-French 30 industry as the firm and also
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have positive R&D expenditure.

Other firm variables
R&D intensity Ratio of R&D expenditures (XRD) to total assets (AT), and firms with missing R&D information are assigned
a R&D value of zero. Source: Compustat
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Log (No. patents) Logged number of patents a firm applies for in a year. Source: NBER patent database
Log (No. exploratory patents) Logged number of exploratory patents (i.e., patents filed in technology classes that the firm did not file any
patents in the previous five years) a firm applies for in a year. Source: NBER patent database.
Patent diversity (Inverse of the) Herfindahl index of patents a firm filed in a year in different technology classes. Source:
NBER patent database.
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Log (No. citations) Logged number of citations a firm’s patents subsequently receive. Source: NBER database
Log (Average no. citations) Logged (number of citations/ number of patents). Source: NBER patent database
Log (No. analysts) Logged number of analyst estimates (NUMEST). Source: I/B/E/S
Sales (($Mil.)) Annual sales (SALE) in millions of USD. Source: Compustat
Market-book ratio Ratio of market value of assets to book value assets. Market value of assets is defined as total assets plus
market equity minus book equity. Market equity is computed by multiplying common shares outstanding by
fiscal-year closing price. Book equity refers to stockholders’ equity. Source: Compustat
Sales growth Five year geometric growth in SALE. Source: Compustat
Book leverage Debt in current liabilities plus long-term debt (DLTT) divided by total assets (AT). Source: Compustat
ROA Net income (NI) divided by total assets (AT). Source: Compustat
Std. (ROA) Standard deviation of ROA for the prior five years. Source: Compustat
Cash Ratio of cash holdings (CH) totota assets (AT). Source: Compustat
Tangibility Property, plant and equipment (PPE) divided by lagged total assets (AT). Source: Compustat
Unionization rate Percentage of workers covered by collective bargaining agreements at the CIC industry level. Source:
www.unionstats.com
Appendix (cont’d)

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CEO network Number of individuals a CEO overlapped with through employment, education, and other activities in the
Boardex database. Source: Boardex.
Capital expenditure Capital expenditure (CAPX) scaled by total assets (AT). Source: Compustat
Industry HHI Herfindahl Hirschman Index for the issuer’s 3-digit SIC code, calculated as ∑𝑁 2
𝑖=1 𝑠𝑖 , where si is the
proportion of sales of firm i in the issuer’s 3-digit SIC industry and N is the number of firms in the industry.
Source: Compustat
Institutional ownership Equity ownership by institutions holding at least 5 percent. Source: Thomson Financial.
Table 1: Summary Statistics
The following table provides the descriptive statistics of the various variables used in our study. The definitions of the
variables are included in the Appendix.

Mean Std. Dev. Min Median Max No. Obs.

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Panel 1A: Network Variables
Centrality measures (%)

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Degree 0.31 0.25 0.042 0.24 2.14 15,779
Eigenvector 2.12 0.99 0.044 2.41 4.98 15,779
Betweenness 0.024 0.038 0 0.002 0.36 15,779

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Cohesion measure (%)
Density 15.33 13.54 0 10.00 100.00 13,598
Diversity measures
Industry diversity 4.39 3.28 0 3.25 22.27 15,779

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Network non-redundancy 3.69 2.82 1 3.00 21.28 15,779
Innovativeness measure
Network innovativeness 3.36 3.43 0 2.00 22 14,015
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Propinquity measure
Geographic propinquity 1.14 1.66 0 1.00 16 12,902
Industry propinquity 0.82 1.21 0 0 10 13,691
Innovative propinquity measure
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Innovative geographic propinquity 0.52 0.98 0 0 10 12,902

Innovative industrial propinquity 0.55 1.04 0 0 10 13,691
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Panel 1B: Other Firm Variables

R&D intensity 0.036 0.058 0 0.005 0.29 15,764
Number of patents 16.67 112.01 0 0 4108 8,557
Number of exploratory patents 0.71 2.14 0 0 38 8,347
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Patent diversity 4.29 4.75 1 2.67 50.93 2,844

Number of citations 130.88 1,174.50 0 0 53,323 8,524
Average number of citations 1.78 4.97 0 0 101.88 8,524
Sales ($ billions)
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5.6 12.76 0 1.4 86.85 15,770

Market-book ratio 1.92 1.11 0.70 1.57 6.91 15,725
Sales growth 0.097 0.15 -0.26 0.072 1.23 15,351
Book leverage 0.22 0.19 0 0.20 0.87 15,776
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ROA 0.03 0.13 -0.68 0.05 0.27 15,767

Cash 0.11 0.11 0.001 0.08 0.55 15,624
Unionization rate (%) 9.27 9.80 0 5.5 74.1 14,632
Capital expenditure 0.048 0.047 0.001 0.033 0.337 15,487
Industry HHI 0.321 0.217 0.037 0.262 1 3,417
CEO network 628.18 733.73 0 394 6,033 5,534
Analyst estimates 9.75 7.18 1 8 49 14,837
Institutional ownership 0.81 0.17 0.18 0.84 1.03 12,150

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Table 2: Firm Network Connectedness and R&D Intensity

Panel A provides the estimated coefficients of linear regressions of R&D intensity using the full sample. In Panel B, the
regressions are estimated for subsamples of firms in intangible and tangible industries, respectively, and only the estimated
coefficients on the network variables are reported. P-values are based on robust cluster-adjusted standard errors and are
provided in parentheses. ***, **, and * correspond to significance at the 1, 5, and 10 percent level, respectively.

Panel 2A: Full Sample

Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Network
Centrality 0.0032***
(0.00)
Density 0.0000

T
(0.91)
Diversity 0.0009**

IP
(0.02)
Innovativeness 0.0136***
(0.00)

CR
Geographic propinquity 0.0039**
(0.01)
Innovative geographic propinquity 0.0129***
(0.00)

US
Log (Sale) -0.0046*** -0.0032*** -0.0045*** -0.0073*** -0.0043*** -0.0047***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Market-book ratio 0.0118*** 0.0120*** 0.0124*** 0.0117*** 0.0120*** 0.0115***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
AN
Debt ratio -0.0119** -0.0114** -0.0139*** -0.0139*** -0.0140*** -0.0130**
(0.02) (0.03) (0.01) (0.01) (0.01) (0.01)
ROA -0.0771*** -0.0790*** -0.0738*** -0.0673*** -0.0720*** -0.0707***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Cash 0.0841*** 0.0846*** 0.0859*** 0.0787*** 0.0881*** 0.0856***
M

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)

Sales growth 0.0210*** 0.0164** 0.0235*** 0.0304*** 0.0212** 0.0218***
(0.01) (0.04) (0.00) (0.00) (0.01) (0.01)
ED

Unionization rate -0.0005*** -0.0005*** -0.0005*** -0.0005*** -0.0004*** -0.0004***

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Capital expenditure -0.0384*** -0.0403*** -0.0407** -0.0295* -0.0390** -0.0380**
(0.01) (0.00) (0.01) (0.07) (0.02) (0.02)
PT

Industry HHI -0.0171*** -0.0169*** -0.0136** -0.0149*** -0.0141** -0.0139**

(0.00) (0.00) (0.01) (0.01) (0.01) (0.01)
Industry fixed effects Yes Yes Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes Yes Yes
CE

No. Obs. 13,991 13,991 12,265 12,415 11,592 11,592

R-squared 0.462 0.457 0.461 0.481 0.463 0.471
F-statistic 172.7 171.4 149.6 157.5 143.2 148.1
AC

Panel 2B: Sensitivity of R&D Intensity to Network Measures for Intangible and Tangible Industry Subsamples
Intangible No. Obs. Tangible No. Obs. Diff. in coefficients χ2
Centrality 0.0045*** 9,454 0.0003 4,537 17.47***
(0.00) (0.27)
Density 0.0000 9,454 0.0000 4,537 0.01
(0.75) (0.39)
Diversity 0.0008 8,299 0.0003 3,966 0.67
(0.14) (0.16)
Innovativeness 0.0162*** 8,391 0.0024*** 4,024 46.62***
(0.00) (0.00)
Geographic propinquity 0.0050** 7,823 0.0012 3,769 2.63*
(0.02) (0.13)
Innovative geo. propinquity 0.0154*** 7,823 0.0034** 3,769 13.51***
(0.00) (0.02)

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Table 3: Firm Network Connectedness and Patents

Panels A-C provide the estimated coefficients of linear regressions of various patent measures using the full sample. In Panel
D, the regressions are estimated for subsamples of firms in intangible and tangible industries, respectively. P-values are
based on robust cluster-adjusted standard errors and are provided in parentheses. ***, **, and * correspond to significance at
the 1, 5, and 10 percent level, respectively.

Panel 3A: Dependent Variable = Log (Number of Patents)

Full Sample Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Network
Centrality 0.0790***
(0.00)
Density -0.0006
(0.62)

T
Diversity 0.0527***
(0.00)

IP
Innovativeness 0.2079***
(0.00)
Geographic propinquity 0.1166***

CR
(0.01)
Innovative geo. propinquity 0.2462***
(0.00)
Log (Sale) 0.3526*** 0.3872*** 0.3383*** 0.3364*** 0.3509*** 0.3453***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)

US
Market-book ratio 0.1224*** 0.1252*** 0.1341*** 0.1348*** 0.1392*** 0.1355***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Debt ratio -0.3557*** -0.3479*** -0.4315*** -0.4261*** -0.4102*** -0.4045***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
ROA -0.5926*** -0.6354*** -0.6056*** -0.5821*** -0.6610*** -0.6553***
AN
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Cash -0.0444 -0.0453 -0.0642 -0.1316 -0.0245 -0.0576
(0.82) (0.81) (0.77) (0.53) (0.91) (0.79)
R&D intensity 4.5868*** 4.7588*** 4.9581*** 4.4884*** 4.5910*** 4.3810***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
M

Sales growth -0.6230*** -0.7262*** -0.6091*** -0.6364*** -0.5855*** -0.5833***

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Unionization rate -0.0070* -0.0065* -0.0076* -0.0077* -0.0090** -0.0090**
ED

(0.07) (0.09) (0.07) (0.07) (0.03) (0.03)

Capital expenditure 0.2787 0.2288 0.4613 0.5085 0.3952 0.3792
(0.48) (0.57) (0.32) (0.26) (0.39) (0.42)
Industry HHI 0.2359 0.2370 0.1796 0.2076 0.1286 0.1374
(0.12) (0.12) (0.25) (0.20) (0.40) (0.37)
PT

Industry fixed effects Yes Yes Yes Yes Yes Yes

Year fixed effects Yes Yes Yes Yes Yes Yes
No. Obs. 7,498 7,498 6,643 6,659 6,222 6,222
R-squared 0.454 0.449 0.467 0.469 0.440 0.444
F-statistic
CE

83.94 81.67 82.37 82.80 69.88 71.24

Panel 3B: Dependent Variable = Log (Number of Exploratory Patents)

Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Centrality 0.0265***
AC

(0.01)
Density -0.0005
(0.26)
Diversity 0.0246***
(0.00)
Innovativeness 0.0759***
(0.00)
Geographic propinquity 0.0379**
(0.02)
Innovative geo. propinquity 0.0969***
(0.00)
Additional control variables Yes Yes Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes Yes Yes
No. Obs. 7,342 7,342 6,506 6,520 6,088 6,088
R-squared 0.326 0.323 0.339 0.337 0.310 0.315
F-statistic 47.30 46.83 46.45 45.97 38.75 39.30

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Panel 3C: Dependent Variable = Patent Diversity

Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Centrality 0.1927
(0.11)
Density -0.0008
(0.90)
Diversity 0.1649***
(0.00)
Innovativeness 0.6759***
(0.00)
Geographic propinquity 0.1071
(0.60)
Innovative geo. propinquity 0.3439
(0.19)

T
Additional control variables Yes Yes Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes Yes Yes

IP
Year fixed effects Yes Yes Yes Yes Yes Yes
No. Obs. 2,519 2,519 2,363 2,361 2,177 2,177
R-squared 0.355 0.352 0.359 0.360 0.337 0.339

CR
F-statistic 17.71 17.67 17.27 17.25 13.72 13.72

Panel 4D: Sensitivity of Patent Measures to Network Measures for Intangible and Tangible Subsamples
Panel 4D1: Dependent variable = Log (Number of Patents) Intangible No. Obs. Tangible No. Obs. Diff. in coefficients χ2
Centrality 0.1029*** 5,079 0.0328 2,419 3.40*

US
(0.00) (0.20)
Density -0.0010 5,079 0.0003 2,419 0.45
(0.51) (0.79)
Diversity 0.0728*** 4,499 0.0159 2,144 5.15**
(0.00) (0.30)
AN
Innovativeness 0.2926*** 4,515 0.0724 2,144 10.26***
(0.00) (0.11)
Geographic propinquity 0.1166** 4,194 0.0919* 2,028 0.09
(0.03) (0.09)
Innovative geo. propinquity 0.2549*** 4,194 0.1496 2,028 0.67
M

(0.00) (0.11)
Panel 4D2: Dependent Variable = Log (Number of Exploratory Patents)
Centrality 0.0296** 4,992 0.0167 2,350 0.70
ED

(0.02) (0.16)
Density -0.0006 4,992 0.0001 2,350 0.71
(0.27) (0.90)
Diversity 0.0297*** 4,426 0.0109* 2,080 3.93**
(0.00) (0.07)
PT

Innovativeness 0.0913*** 4,439 0.0422** 2,081 2.95*

(0.00) (0.04)
Geographic propinquity 0.0329* 4,122 0.0328 1,966 0.01
(0.06) (0.19)
CE

Innovative geo. propinquity 0.0964*** 4,122 0.0684* 1,966 0.32

(0.00) (0.08)
Panel 4D3: Dependent Variable = Patent Diversity
Centrality 0.2189 2,055 0.1494 464 0.13
(0.16) (0.11)
AC

Density -0.0003 2,055 0.0049 464 0.12

(0.97) (0.70)
Diversity 0.2275*** 1,911 0.0399 452 3.34*
(0.00) (0.53)
Innovativeness 0.8522*** 1,910 0.3446* 451 2.02
(0.00) (0.05)
Geographic propinquity -0.0149 1,769 0.7579** 408 4.34**
(0.95) (0.01)
Innovative geo. propinquity 0.2337 1,769 0.9907** 408 1.86
(0.42) (0.03)

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Table 4: Firm Network Connectedness and Citations

Panels A-B provide the estimated coefficients of linear regressions of two patent citations measures using the full sample. P-
values are based on robust cluster-adjusted standard errors and are provided in parentheses. ***, **, and * correspond to
significance at the 1, 5, and 10 percent level, respectively.

Panel 4A: Dependent Variable = Log (Number of Citations)

Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Network
Centrality 0.0804**
(0.03)
Density -0.0007
(0.68)
Diversity 0.0630**

T
(0.01)
Innovativeness 0.2378***

IP
(0.00)
Geographic propinquity 0.1338**
(0.03)

CR
Innovative geo. propinquity 0.2974***
(0.01)
Log (Sale) 0.4096*** 0.4447*** 0.3835*** 0.3842*** 0.4062*** 0.3985***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Market-book ratio 0.1818*** 0.1847*** 0.1909*** 0.1912*** 0.1995*** 0.1947***

US
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Debt ratio -0.4906*** -0.4828*** -0.6098*** -0.6076*** -0.5825*** -0.5745***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
ROA -0.8204*** -0.8634*** -0.8317*** -0.8085*** -0.8834*** -0.8759***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
AN
Cash 0.1379 0.1361 0.2087 0.1172 0.2472 0.2084
(0.62) (0.62) (0.53) (0.71) (0.45) (0.52)
R&D intensity 5.2838*** 5.4583*** 5.6740*** 5.1502*** 5.2375*** 4.9799***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Sales growth -0.8508*** -0.9558*** -0.8442*** -0.8792*** -0.7876*** -0.7822***
M

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)

Unionization rate -0.0057 -0.0052 -0.0065 -0.0065 -0.0088 -0.0088
(0.34) (0.37) (0.32) (0.33) (0.20) (0.19)
Capital expenditure 0.4631 0.4120 0.7270 0.7847 0.6880 0.6730
ED

(0.29) (0.37) (0.16) (0.12) (0.20) (0.22)

Industry HHI 0.2750 0.2761 0.1845 0.2212 0.1596 0.1698
(0.14) (0.14) (0.34) (0.27) (0.41) (0.38)
Industry fixed effects Yes Yes Yes Yes Yes Yes
PT

Year fixed effects Yes Yes Yes Yes Yes Yes

No. Obs. 7,498 7,498 6,643 6,659 6,222 6,222
R-squared 0.405 0.403 0.420 0.420 0.396 0.399
F-statistic 71.27 70.39 71.05 70.87 60.10 61.08
Panel 4B: Dependent Variable = Log (Average Number of Citations)
CE

Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Centrality 0.0271*
(0.06)
Density -0.0003
AC

(0.70)
Diversity 0.0220**
(0.03)
Innovativeness 0.0900**
(0.01)
Geographic propinquity 0.0412
(0.10)
Innovative geo. propinquity 0.0906**
(0.03)
Additional control variables Yes Yes Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes Yes Yes
No. Obs. 7,498 7,498 6,643 6,659 6,222 6,222
R-squared 0.344 0.343 0.358 0.359 0.342 0.343
F-statistic 77.80 76.89 77.20 77.30 64.10 64.85

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Table 5: Two-Stage Least Squares Estimates of Firm Network Connectedness and R&D Intensity
Table 5 presents two-stage least squares coefficient estimates of R&D intensity regressed on measures of network connectedness.
The instruments are the number of logged public companies and logged average distance. Panel 5A provides first-stage
coefficient estimates for these instruments, and Panel 5B provides second-stage estimates for the instrumental variables and
additional control variables. P-values are provided in parentheses. ***, **, and * correspond to significance at the 1, 5, and 10
percent levels, respectively.

Panel 5A: First Stage Estimates Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Log (Public companies) 0.033*** -0.003 0.050** 0.0376*** 0.018*** 0.022***
(0.00) (0.97) (0.02) (0.00) (0.00) (0.00)
Log (Distance) -0.010 0.057 -0.045 -0.0010 -0.039 -0.024
(0.82) (0.88) (0.56) (0.97) (0.13) (0.20)

T
Additional control variables Yes Yes Yes Yes Yes Yes

IP
Panel 5B: Second Stage Estimates
Network
Centrality 0.0355***

CR
(0.01)
Density -0.0464
(0.86)
Diversity 0.0196**
(0.03)

US
Innovativeness 0.0283***
(0.00)
Geographic propinquity 0.0502***
(0.01)
AN
Innovative geo. propinquity 0.0487***
(0.00)
Log (Sale) -0.0188*** -0.0635 -0.0240*** -0.0116*** -0.0093*** -0.0073***
(0.00) (0.86) (0.01) (0.00) (0.00) (0.00)
M

Market-book ratio 0.0098*** 0.0060 0.0100*** 0.0109*** 0.0098*** 0.0097***

(0.00) (0.87) (0.00) (0.00) (0.00) (0.00)
Debt ratio -0.0181** 0.0377 -0.0232*** -0.0148*** -0.0076 -0.0096
ED

(0.01) (0.90) (0.00) (0.01) (0.31) (0.13)

ROA -0.0557*** 0.1303 -0.0518*** -0.0563*** -0.0657*** -0.0629***
(0.00) (0.91) (0.00) (0.00) (0.00) (0.00)
Cash 0.0775*** -0.2315 0.0880*** 0.0720*** 0.0941*** 0.0801***
(0.00) (0.90) (0.00) (0.00) (0.00) (0.00)
PT

Sales growth 0.0656*** 0.0904 0.0893*** 0.0395*** 0.0365*** 0.0250***

(0.00) (0.84) (0.01) (0.00) (0.00) (0.00)
Unionization rate -0.0006*** -0.0020 -0.0008*** -0.0005*** -0.0003* -0.0004**
(0.00) (0.83) (0.00) (0.00) (0.06) (0.01)
CE

HHI -0.0267*** -0.0564 -0.0254*** -0.0254*** -0.0254*** -0.0242***

(0.00) (0.76) (0.01) (0.00) (0.00) (0.00)
Capital expenditure -0.0201 -0.1890 -0.0265 -0.0197 -0.0161 -0.0296
(0.48) (0.82) (0.39) (0.39) (0.56) (0.18)
AC

Industry fixed effects Yes Yes Yes Yes Yes Yes

Year fixed effects Yes Yes Yes Yes Yes Yes
No. Obs. 12,976 12,976 11,557 11,548 10,943 10,943
R-squared 0.043 -108.787 0.060 0.458 0.261 0.403
F-statistic 16.49 0.313 14.67 23.80 17.59 20.70
K-P LM statistic 11.337 0.030 7.353 37.947 19.596 46.889
(p-value) (0.00) (0.98) (0.02) (0.00) (0.00) (0.00)
Hansen J statistic 0.000 0.061 0.059 0.018 0.133 0.000
(p-value) (0.99) (0.80) (0.81) (0.89) (0.72) (0.99)

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Table 6: Differences-in-Differences Regressions Using R&D Intensity as the Outcome Variable

Panel A provides states that increased R&D tax credits between 2000-2006 using information provided by Daniel Wilson’s
website. Panel B provides differences-in-differences estimates using R&D intensity for firms incorporated in these states
based on the year of the tax credit increase, matched on Fama-French 30 industry and size (sales). P-values are based on
robust cluster-adjusted standard errors and are provided in parentheses. ***, **, and * correspond to significance at the 1, 5,
and 10 percent level, respectively.

Panel A: States that Increased R&D Tax Credits between 2000 and 2006
State Year Tax Credit (%)
CA 2000 15.0
HI 2000 20.0

T
ID 2001 5.0
IL 2004 7.0

IP
IN 2003 10.0
LA 2003 8.0

CR
MD 2000 10.0
NE 2006 3.0
OH 2004 7.0
SC 2001 3.0

US
SC 2002 5.0
TX 2001 4.0
TX 2002 5.0
VT 2003 10.0
AN
Panel B: R&D Tax Credit Increases and R&D Intensity
M

Model (1) Model (2) Model (3)

Full Sample Centrality Centrality
Tercile 3 Terciles 1-2
ED

Constant 0.0338*** 0.0357*** 0.0337***

(0.00) (0.00) (0.00)
Tax credit increase -0.0110 -0.0170 -0.0100
(0.26) (0.12) (0.46)
Post 0.0549 0.0064 0.0914
PT

(0.16) (0.63) (0.17)

Tax credit increase * Post 0.0268 0.0504** 0.0032
(0.57) (0.05) (0.97)
Year fixed effects Yes Yes Yes
CE

No. Obs. 460 161 299

R-squared 0.068 0.115 0.083
F-statistic 3.459 2.823 2.167
AC

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Table 7: Bond- and Firm-level Summary Statistics

Table 7 provides the summary statistics for 2,769 at-issue bond observations in the primary sample based on 549
unique firm issuers over the sample period 2000-2013. The variable descriptions are provided in the Appendix.

Panel A: Bond Issue Characteristics

No. Issues Proportion of Sample
Embedded Options
Callable 1,847 0.6670
Putable 7 0.0025
Credit (Moody) rating:
Aaa 33 0.0119
Aa1-Aa3 233 0.0841

T
A1-A3 803 0.2900
Baa1-Baa3 1,034 0.3734

IP
Ba1-Ba3 341 0.1231
B1-B3 282 0.1018
Caa1-Ca 43 0.0155

CR
Panel B: Pooled Bond Characteristics
Mean St Dev. Min Median Max
Yield to maturity 0.0531 0.0218 0.0084 0.0537 0.0661

US
Yield spread 0.0216 0.0177 -0.0091 0.0162 0.0288
Time to maturity (years) 11.1580 8.1207 2.2630 10.0137 10.0630
Coupon rate 0.0526 0.0218 0.0045 0.0535 0.0660
Proceeds amount ($Mil.) 1,337 2,620 3.308 747 48,932
AN
No. Obs. 2,769

Panel C: Pooled Issuer Characteristics

Mean Std. Dev. Min Median Max
M

Innovation measures
RD Intensity 0.0202 0.0420 0.0000 0.0005 0.6255
No. Cites (No. obs. = 823) 558 4,634 0 0 53,323
ED

No. Patents (No. obs. = 823) 56 366 0 0 4,108

Financial control variables
No. estimates 15.2929 7.6762 1 14 43
Market-book ratio 1.8033 0.7960 0.6839 1.5588 5.8425
PT

Sales growth 0.0811 0.1201 -0.2779 0.0603 0.9320

ROA 0.0607 0.0651 -0.5854 0.0607 0.3419
Std. ROA 0.0350 0.0458 0.0005 0.0216 0.7818
Book leverage 0.0317 0.1476 0.0000 0.2900 1.5210
CE

Sales ($mil) 29,558 55,288 138 11,067 444,948

No. Obs. 2,769
AC

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Table 8: Impact of Innovation on Yield Spread Conditional on the Level of Network Centrality
Table 8 presents the results of OLS regressions of yield spread regressed on the three innovation measures and additional
control variables, estimated over subsets based on Centrality terciles. All the regressions include year and industry fixed
effects, and standard errors are clustered by firm. P-values based robust standard errors are reported in parentheses. *, **,
and *** denote significance at the 10-, 5-, and 1-percent levels, respectively.

Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Centrality Centrality Centrality Centrality Centrality Centrality
Tercile 3 Terciles 1-2 Tercile 3 Terciles 1-2 Tercile 3 Terciles 1-2
R&D intensity -0.0170*** 0.0085
(0.00) (0.13)
Log (Number of patents) -0.0005* 0.0005**

T
(0.09) (0.02)
Log (Number of citations) -0.0004** 0.0004**

IP
(0.05) (0.04)
Centrality -0.0004 -0.0001 -0.0004 -0.0006** -0.0004 -0.0006**
(0.11) (0.53) (0.41) (0.04) (0.48) (0.05)

CR
Residual bond rating -0.0011*** -0.0008*** -0.0007** -0.0008*** -0.0008** -0.0008***
(0.00) (0.00) (0.04) (0.00) (0.03) (0.00)
Callable 0.0010** 0.0003 -0.0012 -0.0010* -0.0011 -0.0010*
(0.02) (0.30) (0.31) (0.08) (0.32) (0.07)

US
Putable 0.0011 -0.0020 -0.0023 0.0056*** -0.0029 0.0057***
(0.25) (0.62) (0.41) (0.00) (0.32) (0.00)
Coupon rate 0.6823*** 0.7977*** 0.6111*** 0.7807*** 0.6112*** 0.7790***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Time to maturity -0.0004*** -0.0005*** -0.0001** -0.0001*** -0.0001** -0.0001***
AN
(0.00) (0.00) (0.03) (0.00) (0.03) (0.00)
Log (Issue amount) -0.0000 0.0000 0.0002 0.0006** 0.0002 0.0007**
(0.89) (0.88) (0.73) (0.04) (0.77) (0.03)
Monthly Baa–Aaa spread 0.7326*** 0.7145*** 0.9940*** 1.3742*** 1.0044*** 1.3752***
M

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)

Log (No. estimates) -0.0006 -0.0010*** -0.0010 -0.0015*** -0.0008 -0.0015***
(0.25) (0.00) (0.22) (0.00) (0.31) (0.00)
ED

Market-book ratio -0.0006 -0.0008** -0.0012* -0.0007 -0.0014** -0.0007

(0.22) (0.01) (0.07) (0.27) (0.03) (0.29)
Sales growth 0.0015 0.0027* -0.0034 0.0024 -0.0031 0.0023
(0.40) (0.06) (0.40) (0.32) (0.42) (0.35)
PT

ROA -0.0108 -0.0101*** 0.0115 -0.0059 0.0103 -0.0059

(0.18) (0.00) (0.17) (0.18) (0.25) (0.19)
Std. ROA 0.0265*** 0.0159*** 0.0310** 0.0336*** 0.0291** 0.0337***
(0.00) (0.00) (0.02) (0.00) (0.02) (0.00)
CE

Book leverage 0.0038** 0.0045*** 0.0017 0.0043** 0.0015 0.0043**

(0.04) (0.00) (0.72) (0.01) (0.74) (0.01)
Log (Sale) -0.0008*** -0.0003 -0.0004 -0.0001 -0.0005 -0.0001
(0.00) (0.11) (0.48) (0.75) (0.39) (0.78)
Year fixed effects Yes Yes Yes Yes Yes Yes
AC

Industry fixed effects Yes Yes Yes Yes Yes Yes

No. Obs. 939 1,830 275 548 275 548
R-squared 0.905 0.930 0.874 0.923 0.875 0.923
F-statistic 120.5 412.1 91.63 124.5 114.0 123.5

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Table 9: Firm Network and Bond Yield Spread Changes Surrounding Patent Filing Dates
Table 9 presents changes in yield spreads surrounding patent filing dates based on the closest transaction days prior to- and
following the filing date. The sample is based on 141 issuers with a total of 360 issues trading within 30 days prior to- and
following the filing date. In Panel B, multiple bond yield spreads from the same issuer are weighted using the par amounts of
each issue as weights. Panel C provides least squares coefficient estimates using bond-level changes in yield spread as the
dependent variable. Yield spreads are winsorized at the 2.5 percent tails. *, ** and *** indicate significance at 10 percent, 5
percent and 1 percent levels, respectively.

Panel A: Bond- and Issuer Level Descriptive Statistics

Mean Std. Dev. Min Median Max
Pre-filing firm-level yield spread 0.0236 0.0228 -0.0129 0.0165 0.1128

T
Pre-filing trading volume ($000) 3,701 5,492 5 1,526 280,000
Days between transaction and filing date 10.014 7.873 1 7 29

IP
Post-filing firm-level yield spread 0.0224 0.0215 -0.0136 0.0145 0.0997
Post-filing trading volume ($000) 5,119 15,400 2 1,406 154,000
Days between filing and transaction date 9.565 8.656 1 7 30

CR
Time to maturity (years) 9.267 8.175 0.0740 6.805 38.9178
Bond (Moody’s) rating 8.244 3.539 1 (Aaa) 8 (Baa1) 21 (Ca)
Bond age 3.378 2.256 0.000 2.256 18.447
Centrality 0.9262 1.4946 -2.1870 0.8014 4.5993

US
Sales 20,448 53,121 451 5,308 345,977
Panel B: Change in Firm-level (Weighted Average) Yield Spread by Centrality Terciles
No. Obs. Pre-Filing Post-Filing Change in spread P-value
Full sample 141 0.0236 0.0224 -0.0013* 0.062
AN
(0.0165) (0.0145) (-0.0013)*** (0.000)
Centrality tercile 3 47 0.0191 0.0166 -0.0025*** 0.000
(0.0136) (0.0133) (-0.0024)*** (0.000)
Centrality terciles 1-2 94 0.0259 0.0253 -0.0006 0.507
M

(0.0202) (0.0176) (-0.0007)** (0.010)

Panel C: Regressions of Bond-level Changes in Yield Spread
Model (1) Model (2)
Centrality 0.0003 0.0003
ED

(0.204) (0.137)
Centrality × Maturity less than 5y -0.0009*
(0.080)
Maturity less than 5y 0.0022***
PT

(0.005)
Centrality × Maturity less than 3y -0.0020**
(0.013)
Maturity less than 3y 0.0011
CE

(0.369)
Bond (Moody’s) rating 0.0002 0.0003
(0.300) (0.129)
Log (Bond age) 0.0010*** 0.0010**
AC

(0.007) (0.010)
Log (Total trading volume) 0.0000 0.0001
(0.917) (0.603)
Log (Total days surrounding filing date) 0.0012** 0.0012**
(0.025) (0.027)
Log (Sale) 0.0003 0.0003
(0.565) (0.495)
Year fixed effects Yes Yes
Firm level fixed effects Yes Yes
No. Obs. 360 360
R-squared 0.405 0.394
F-statistic 6.328 5.951

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Highlights

 We study how network connectedness affects innovation and pricing of innovation.

 We use board interlocks to construct various firm network measures.
 Different network characteristics affect firm innovation input and output.
 The type of industry has a bearing on the connectedness-innovation relation.
 The impact of innovation on bond yield spreads depends on network connectedness.

T
IP
CR
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PT
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