The impact of corporate governance provisions on R&D intensity:

a closer look at corporate governance in an international

perspective

Author:
D. M Weeder
S2202735

Supervisor:
prof. dr. C.L.M. Hermes
Co-assessor:
Dr. S. Homroy
External supervisor:
A. de Ridder

June 8, 2018

Msc. International Financial Management, DD program

Faculty of Business and Economics, University of Groningen
Department of Business Studies, Uppsala Universitet

Abstract:
Using panel data analysis, this paper considers the impact of governance provisions on firm’s
R&D investment decisions. The current paper also contributes to the literature on corporate
governance and innovation by introducing an interaction dimension which captures the
influence that internationalization of U.S. firms may have on R&D investment decisions. Based
on a sample of 627 U.S. firms for the years 2008-2016 this paper’s results suggest that
governance provisions do not nurture or impede R&D investments, and therefore the results
casts doubt on the existence of a relationship between governance provisions and R&D
intensity. The current paper’s findings also suggest that proposed effects of internationalization
do not modify the relationship between entrenchment and R&D for U.S. firms.

Keywords: Firm internationalization, corporate governance, governance provisions,

research and development investment, managerial entrenchment, managerial
myopia
 1. Introduction

Investments in innovative activities such as research and development (henceforth, R&D) play
a critical role in the creation of new products and processes, driving firms to attain higher
efficiency and long run competitive advantages (Holmstrom, 1989). Although investments in
R&D are vital to the long term value of firms (Hitt et al., 1996), R&D investments bear
increased risk with respect to return on investment, in particular on short run accounting
performance measures (Bhagat and Welch, 1995; Hoskisson et al., 1993). As a result, managers
and shareholders may have differing attitudes towards opportunities and risks associated with
R&D investments.

From an agency perspective, delegation of R&D investment decisions to managers may lead to
conflicts of control between shareholders and managers of the firm (Jensen and Meckling,
1976). First and foremost, shareholders and managers have different perceptions of, and
attitudes towards the risk of R&D investment (Becker-Blease, 2011). Secondly, shareholders
have asymmetric information compared to managers on investment in innovative activities. To
align interest of managers with interests of shareholders, shareholders must address the
difficulties regarding external valuation of risk and high costs of monitoring managerial efforts
to innovate. The agency framework assumes that when managers are insufficiently monitored
they will exhibit opportunistic behaviors, resulting in agency costs. Therefore, shareholders aim
to install an effective framework of corporate governance mechanisms to counteract such
agency costs. Effective corporate governance mechanisms are paramount for shareholders to
mitigate agency costs associated with the separation of ownership and control, considering the
vitality of R&D investment strategies for firms’ long-term success (Holmstrom, 1989).

A considerable number of studies focus on the relationship between corporate governance and
market value, whilst only a limited body of research addresses the relationship between
corporate governance practices and R&D. Recent prior studies have empirically found
contradicting results regarding the relationship between corporate governance practices and
innovation (Atanassov, 2013; Becker-Blease, 2011; Chakraborty et al., 2014; Chemmanur and
Tian, 2018). Consequently, theoretical consensus regarding how corporate governance affects
firm’s innovation investment strategy has not yet emerged (Chemmanur and Tian, 2018).
Moreover, academics studying finance and innovation often neglect the influence of corporate

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governance, or merely view corporate governance as a control variable for exogeneity in their
studies of firm performance.

This paper distinguishes itself from preceding agency studies by introducing an interaction
dimension, capturing the influence that internationalization may have on firms’ managerial
R&D decision-making. Arguing that internationalization both reduces the informational
asymmetry and provides shareholders with a broader set of governance mechanisms to valuate
and monitor managerial efforts to innovate. Moreover, the aftermath of the 2007-2008 collapse
of the global banking system has overturned the corporate governance framework, leading to
renewed interest in the topic from scientists and practitioners.

To do so, this paper positions itself in a strand of the corporate governance literature studying
corporate governance practices that influence shareholders’ rights (Danielson and Karpoff,
2006; Gompers et al., 2003). The current paper studies the influence of a specific type of
corporate governance mechanism: governance provisions. Governance provisions are defined
as any governance mechanism in a firm’s corporate charter or bylaws that is aimed to limit the
shareholders control over management (Bebchuk et al., 2008). This paper attempts to contribute
to the corporate governance debate by exploring for U.S. firms what effect governance
provisions have on investments in R&D, and whether this effect is moderated by an
interactional dimension of firm internationalization.

Based on a sample of 627 U.S. based firms for the years 2008-2016, this paper develops
multiple regression models controlling for the impact of governance provisions on R&D
investments and tests the proposed internationalization effect. The remainder of the paper
proceeds as follows: Section 2 discusses relevant literature and develops hypothesis. Section 3
describes the sample, variables, the empirical methodology used in the regression analysis.
Section 4 depicts descriptive statistics, elaborates on the main regression results and conducts
further analyses. Section 5 concludes, discusses practical implications, suggests further
research and debates some of this papers limitations.

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 2. Literature review and hypothesis development

Prior literature indicates that the presence of governance provisions has implications for
management’s efforts to maximize shareholder value (Gompers et al., 2003). Gompers et al.,
(2003) constructed a governance index containing twenty-four governance provisions and
linking the presence of these provisions to changes in shareholder value. Subsequently,
Bebchuk et al., (2008) empirically found that six out of these twenty-four governance
provisions are the main drivers within the relationship between governance provisions and
shareholder value. Bebchuk et al., (2008) identify that these six provisions all are specifically
aimed at preventing shareholders from forcing a change of control. This implies that the threat
of change of control has a powerful influence on the creation of shareholder value. The
Entrenchment index (henceforth, E-index) is an aggregate of these six provisions ranging from
0 to 6. Consistent with the literature, this paper argues a higher E-index implies stronger
protection from change in control (i.e. higher degree of entrenchment). Following the findings
of the Bebchuk et al., (2008), Chakraborty et al., (2014) provide evidence that a higher E-index
is both associated with lower shareholder value and lower innovative performance. This finding
suggests that the inferior shareholder value of high E-index firms may be explained by a
different managerial approach to innovation.

Within the scope of this paper it is examined how the presence of governance provisions
comprising the E-index alter managerial efforts of firms to invest in R&D, and whether this
relation is moderated by a firm’s degree of internationalization. Prior to investigating this
moderating effect of internationalization, the relationship between governance provisions and
the likelihood of managers to invest in R&D is examined through two contrasting strands of
literature. The agency theory framework predicts that a higher degree of entrenchment could
have two opposing effects on managerial incentives to invest in innovative activities (Hitt et
al., 1996; Hoskisson et al., 1993; Stein, 1988).

2.1 Entrenchment view and incentives to invest in R&D

The “managerial entrenchment hypothesis” argues that when managers are protected from a
change in control, they become entrenched and tend to engage in personal utility maximization
at the expense of shareholders (e.g. shirking responsibilities, empire building or extracting
private benefits) (Holmstrom, 1989). A widely-held concern is that a focus on personal utility

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maximization will lead management to cut back on investments (Holmstrom, 1989). This is
especially true for investments in innovative activities because R&D investments are unlikely
to yield direct short-term benefit for managers (Shleifer and Vishny, 1989). This is caused by
the fact that R&D projects have a higher probability of failure compared to routine projects
(Hall, 2002; Hall et al., 2001; Holmstrom, 1989), and are characterized by long term payoff
structures (Vithessonthi and Racela, 2016). This implies that if any revenues of R&D
investments would surface, this would likely happen beyond tenures of management (Dechow
and Sloan, 1991; Gibbons and Murphy, 1992). Independently from entrenchment, prior
findings suggest that managers already have the tendency to underinvest in R&D due to lack of
adequate incentives (Holmstrom, 1989). The entrenchment view predicts that the presence of
governance provisions might further exacerbate this underinvestment in R&D projects through
the pursuit of personal utility maximization.

Prior empirical findings underpin this negative relationship between governance provisions and
R&D expenditures. For example, Mahoney et al., (1997) show that the introduction of
governance provisions results in lower long-term investments. Meulbroek et al. (1990) find that
firms decrease R&D expenditures when management adopts governance provisions. Seru
(2014) shows that conglomerates innovate less when managerial entrenchment increases. Based
on these findings, it may be predicted that the presence of governance provisions (i.e. higher
degree of entrenchment) negatively affects management’s efforts to invest in R&D. This paper
labels that prediction as the entrenchment Hypothesis.

H1a: Management’s R&D expenditures are negatively related to the presence of governance
provisions as expressed by the E-index.

2.2 Managerial myopia view and incentives to invest R&D

An opposing strand of the literature argues that shareholders may apply high or even
disproportionate pressure on management to obtain short term results. A characteristic of R&D
investments is that they encompass projects with high uncertainty and a high probability of
failure (Holmstrom, 1989). Due to this relatively uncertain and more long-term nature of R&D
investments, shareholders must bear depressed accounting earnings in the short term and accept
uncertain rewards in the long term (Manso, 2011). As a result of this, managerial efforts, under
the influence of shareholder incentives, may shift away from long term R&D projects to short

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term projects with more certain payoff structures (Chemmanur and Tian, 2018). Previous
literature labels this phenomenon “corporate myopia”.

Corporate myopia also relates to Stein’s (1988) “managerial myopia view”. Managerial myopia
view states that due to information asymmetry shareholders cannot properly assess the potential
of management’s investment in long-term innovation (Meulbroek et al., 1990; Stein, 1998). It
may be argued that R&D activities are specifically associated with information asymmetry for
two reasons. Firstly, R&D innovations are likely to be an intangible asset that is often,
compared to tangible assets, difficult to valuate for shareholders (Stein, 1988). Secondly, R&D
investments are clouded by secrecy to protect their competitive advantage (Humphery-Jenner,
2014). Consequently, short-term oriented equity market investors (i.e. shareholders) will be
prone to undervalue the shareholders’ value of firms’ investments in long-term R&D
(Chemmanur and Tian, 2018). The potential undervaluation of innovative firms results in an
increased likelihood to be targeted for hostile acquisition attempts (Meulbroek et al., 1990).
Managers might try to reduce information asymmetry by cutting down on R&D investment
(Meulbroek et al., 1990). By shifting efforts to routine tasks with more certain short-term
returns, market value is increased through the reduction of R&D associated undervaluation
(Chakraborty et al., 2014). Hence, according to the myopia view, managers attempt to reduce
the threat of hostile acquisition by diminishing information asymmetry between managers and
shareholders through R&D investment reductions.

In the managerial myopia view, governance provisions that hinder the change of control and
insulate managers from hostile acquisition pressures will enable managers to overcome
shareholder induced myopia. In diametrical opposition to the entrenchment hypothesis, this
theory suggest that governance provisions will incentivize firm’s R&D investment (Humphery-
Jenner and Powell, 2011; Shleifer and Vishny, 1989; Stein, 1988).

This proposed relationship between managerial myopia and R&D investment has been
described by prior empirical contributions as being determined by two distinct types of
shareholders. The first shareholder type is characterized by a long-term investment strategy,
positively influencing investment in R&D activities. The second shareholder type has a short-
term investment strategy, focused on certain and quick payoffs and reducing investment in
R&D. For example, Aghion et al., (2013) find that when a firm has a larger percentage of
institutional long-term investors, managers are prone to invest more in R&D. Similar results

6
are produced by Lerner et al., (2011), finding that a higher percentage of privately owned shares
- implying a more long-term orientation- as opposed to publicly owned shares leads to more
innovative investment.
In short, shareholders that are characterized by longer investment horizons are more focused on
innovation and less likely to pressure management to focus on short-term results, alleviating
the managerial myopia problem (Chemmanur and Tian, 2018). Chemmanur and Jiao (2012)
confirm this line of reasoning and show that the adoption of specific governance provisions
enables managers to pursue long-term R&D projects rather than short-term projects. Hence,
sheltering management from short term performance pressures exerted by shareholders
alleviates managerial myopia concerns. Therefore, the presence of governance provisions may
enable managers to engage in long term investments in R&D activities. This paper labels the
prior argumentation as the managerial myopia hypothesis.

H1b: Management’s R&D expenditures are positively related to the presence of governance
provisions as expressed by the E-index.

2.3 Interaction effects of firm internationalization on entrenchment-R&D

relationship

The focus of the current paper is to introduce internationalization as an interaction dimension

within the entrenchment-R&D relationship. This paper investigates whether the degree of
internationalization of U.S. firms modifies how governance provisions affect R&D decision-
making. To further examine this interaction effect, prior theoretical work is examined.

2.3.1 Interaction effects of internationalization on R&D investment within managerial

entrenchment framework

According to the entrenchment view, governance provisions shield management from pressure
exerted by shareholders allowing managers to engage personal utility maximization lose
interest in R&D investment. In this context, the R&D investment outcome will be determined
by the balance between the governance mechanisms that are installed motivating management
to innovate on the one hand, and the amount of pressure that is applied by the external
environment on the other hand. With regard to the former, prior research identified multiple
differences in corporate governance practices around the globe (Becht and Röell, 1999; Porta
et al., 1998). In response, several authors examined the inevitable question whether a “superior”
set of corporate governance mechanisms exists. And if so, whether there is an international

7
convergence towards this composition of superior corporate governance mechanisms (Denis
and McConnell, 2003). Prior works explored and proposed various mechanisms through which
practices could converge around the globe.

For example, Aggarwal et al. (2011) find that international (institutional) investors are a vehicle
through which corporate governance practices migrate. Foreign investors were shown to
transfer superior governance mechanisms to local firms with inferior governance mechanisms.
Therefore, international investors could be associated with corporate governance migration and
convergence towards a set of global standards. Firm internationalization, similarly to
international investments, may be a channel through which governance mechanisms migrate
across borders. More specifically, through internationalization U.S. firms become increasingly
subjected to foreign legal environments that influence shareholder protection (Porta et al.,
1998). Also, internationalization exposes U.S. firms to non-U.S. institutional environments that
influence the shareholders’ capability of monitoring (Aggarwal et al., 2011). U.S. firms
potentially voluntarily or coercively import and adopt ‘exotic’ non-U.S. corporate governance
mechanisms into their U.S. corporate governance framework. In other words, through
internationalization foreign corporate governance mechanisms may migrate and get adopted
into U.S. corporate governance practice. Thus, the degree of internationalization may affect the
governance policies of a given firm, modifying managerial R&D investment outcome.

With regard to external pressure, internationalization may lead firms to interact with different
types of markets for corporate control (Jensen and Ruback, 1983). In particular, it is found that
the threat of hostile acquisitions (i.e. strength and activity of the market for corporate control)
differs between countries and corporate governance frameworks (Denis and McConnell, 2003;
O’Sullivan, 2001; Prowse, 1994). Moreover, Aguilera and Jackson (2003) argue that the
greatest threat of a change in control through hostile acquisitions exists in the U.S. market-
based economy. Essentially, within the U.S. markets-based corporate governance framework
managers are argued to be incentivized mainly by the threat of hostile acquisitions (Koke,
2001).

However, hostile acquisition attempts in for example, Germany (Koke, 2001) and the
Netherlands (Kabir et al., 1997), are highly uncommon compared to the U.S. As far as hostile
acquisition attempts are concerned, there is close-to-none market for corporate control in the
bank-based economies (Koke, 2001). Presumably because in non-U.S. corporate governance

8
frameworks the governance mechanism of threat of hostile acquisitions is partly substituted by
other governance mechanisms (e.g. long-term debt financing, ownership by families and large
block-holders and shareholders litigations) (Becht et al., 2003; Porta et al., 1998). Therefore, a
higher degree of internationalization by U.S. firms suggests exposure to an overall weaker
market for corporate control by inclusion of non-U.S. corporate governance frameworks.

Altogether, when viewing the effect of internationalization through the lens of the entrenchment
view, the effect of governance provisions on R&D expenditures may be influenced by three
factors related to internationalization. Namely, migration of governance mechanisms, altered
monitoring abilities and varying external pressure exerted by the market for corporate control.
Through these factors, the effect of governance provisions examined in this study possibly exert
a reduced effect on the entrenchment-R&D relationship for firms with higher degree of
internationalization. Hence, this paper predicts that a higher degree of internationalization has
a negative interaction effect on R&D investments.

H2a: The negative relationship between management’s R&D investment and governance
provisions is negatively moderated by a higher degree of internationalization

2.3.2 Interaction effects of internationalization on R&D investment within managerial

myopia framework

Alternatively, it may be argued that when firms internationalize, they will face increased
competition from an increased number of foreign competitors. It is argued that an increased
(international) market competition causes firms to disclose more and to be more open to
stakeholders (Nickell et al., 1997). This increased openness is especially beneficial for firms
with high levels of information a-symmetry, such as R&D intensive firms. As explained earlier,
the monitoring and valuation of R&D intensive firms by shareholders is relatively complex.
Consequently, equity market investors are less equipped to appreciate the R&D investments
conducted, and will be prone to undervalue the shareholders’ value of firms investing in long-
term innovative activities (Chakraborty et al., 2014).

Hence, this theory suggests that internationalization of U.S. firms reduces the information a-
symmetries between shareholders and management through increased disclosure as a result of
international competition. So, if the reduced information asymmetries will enable shareholders

9
to more accurately assess the potential of a manager’s investment in innovation, then the
undervaluation effect of information asymmetries will be mitigated by internationalization in
the managerial myopia view. The managerial myopia resulting from the threat of hostile
acquisition and subsequent the underinvestment in R&D are decreased by a higher degree of
firm internationalization. Thus, internationalization dampens short term performance pressures
on management from hostile acquisitions, easing the managerial myopia problem. As a
consequence, governance provisions that protect managers from myopia problems that are
associated with informational a-symmetries exert a reduced influence on the entrenchment-
R&D relationship. Hence, internationalization has a negative interaction effect on R&D
expenditures.

H2b: The positive relationship between management’s R&D investment and governance
provisions is negatively moderated by a higher degree of internationalization.

3. Sample description and methodology

3.1 Sample description

The sample examined in this paper includes U.S. publicly traded firms during the period 2008–
2016. The base sample is constructed by combining data from two different sources. Using
CUSIP company identifiers the governance provisions data from the ‘Institutional Shareholder
Services-governance database’ (formerly RiskMetrics) is merged with financial data regarding
innovation, internationalization and other firm-level control variables from the Compustat
Capital-IQ annual database.

The ISS-governance database covers all firms included in the S&P-1500 index. The S&P 1500
index combines the S&P 500 index with the S&P mid- and the small-Cap indices, covering
approximately 90% of the U.S. market capitalization (Becker-Blease, 2011). Within the ISS-
governance database the S&P 1500 index firms are accompanied with other publicly traded
firms that are primarily selected on market capitalization and high institutional ownership
levels1. Furthermore, Baumol (2004) argues that large established firms, such as largely
represented by the S&P 1500 index, are responsible for the vast majority of investment in R&D.
Whereas this paper’s results indicate that firms in the ISS-Governance database are keenly
adopting governance provisions. Therefore, the ISS-Governance database offers a suitable

1
Manuals and Overviews ISS-Governance database, accessed on May 16, 2018.

10
environment to further examine the relation between governance provisions and investment in
R&D.

This paper adopts a panel dataset to examine the moderating effect of internationalization on
the relationship between governance provisions and investment in R&D for two principal
arguments. First, by estimating a 9-year period this study can apprehend changes in firm’s
degree of internationalization and managerial entrenchment enabling inferences whether these
changes influence firm’s R&D expenditures. Second, by taking a longitudinal instead of a
cross-sectional perspective this study overcomes potential concerns of time specific business
cycle characteristics biasing the regressions analysis.

In order to obtain this paper’s sample, all accessible data on governance provisions within the
ISS-Governance database for U.S. publicly traded firms were obtained for the period between
2007-2016. Resulting in 2,323 unique U.S. firms with 10-year data observations regarding
governance provisions. For all 10 years in this sample these 2,323 firms are supplemented with
firm specific financial data regarding innovation, internationalization and other firm-level
control variables from the Compustat Capital-IQ annual database. Resulting in an unbalanced
panel sample. Preceding the regression analyses, this unbalanced panel sample is trimmed by
means of three limiting factors. First, through introduction of lagged and time-dummy
variables, the observed sample period is shortened by one year. All individual firm observations
from the year 2007 are dropped from the final sample, resulting in a sample spanning a nine-
year period between 2008 and 2016. Despite the reduced number of firm-year observations,
none of the firms were dropped as a result of this data trimming measure. The reasoning behind
the introduction of these variables is further discussed in the methodology section. Secondly,
for the estimation of the fixed effects regression models the statistical software package selected
632 out of the 2,323 firms with sufficient data across all variables and years. This is, all firms
with sufficient data on the variables and years are selected to econometrically responsibly
estimate the fixed effects model. Finally, consistent with the majority of empirical studies on
finance and innovation, firms in finance, banking, insurance and real estate industries are
removed from the final sample2. Reducing the final sample to 627 unique firms with 3,530 firm-
year observations. On average, the sample contains 5.6 years of observations per firm. The
descriptive statistics and correlation matrix is shown in table 2 in the results section.

2 SIC codes ranging 5999 - 6800

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3.2 Methodology

3.2.1 Measurement of variables

3.2.1.1 Measuring independent variable of Entrenchment: Governance Provisions

Following the methodology described in Bebchuk et al. (2008), this paper constructs an
Entrenchment-index (henceforth, E-index) based on six out of twenty-four six governance
provisions included in the ISS – Governance database measuring the strength of shareholder
rights. Bebchuk et al. (2008) discuss that all six provisions within their E-index are aimed at
hindering change of control for incumbent management. A higher E-index implies stronger
entrenchment concerning change in control and vice versa.

The provisions within the E-index could be separated into two distinct types. The first type of
provisions (staggered boards, limits to shareholder amendments of the bylaws, limits to
shareholder amendments of the charter, and supermajority requirements for mergers) pose
statutory constrains on voting power for shareholder to force a change in control at annual
meetings (Bebchuk et al., 2008). The second type (poison pills and golden parachutes) are
designed to increase cost for the acquirer in case of a hostile acquisition attempt, and thus,
insulate management from a change of control as a result of acquisitions attempt (Bebchuk et
al., 2008). Definitions of governance provisions encompassing the E-index are provided in
Appendix II.

All the governance provisions in the E-index are assigned identical weights. Hence, when a
firm introduces or dissolves a governance provision a single point is added or removed from
the E-index. The easy to use and widely-adopted E-index of Bebchuk et al. (2008) owes it
popularity to the fact that their subset of governance provisions has shown to be the strongest
driver for a range of different performance measures (Bebchuk et al., 2013). Since this paper is
interested in the effect of governance provisions on a specific measure of performance this
index is a suitable measure for managerial entrenchment regarding change in control.

3.2.1.2 Measuring dependent variable: R&D expenditure ratios

Innovation is often characterized by a present-day effort that will have potential rewards in the
future, in the form of introduction or improvement of products and services. This study focusses
on the managerial effort to obtain such future benefits. R&D is the crucial predecessor of

12
innovation and therefore R&D expenditures reflect the intensity with which management is
pursuing the potential future benefits of innovation (Danielson and Karpoff, 2006; Lhuillery,
2011). Therefore, R&D expenditure based ratios provide a direct measure for management’s
efforts to innovate. Two common R&D based proxies for innovation are employed: R&D-
intensity ratio and R&D-sales ratio, the former is defined as R&D expenditures in million
dollars divided by total book value of the assets in million dollars and the latter is defined as
R&D expenditures in million dollars divided by total sales in million dollars.

Utilizing R&D expenditures based ratios as proxy for innovation is appealing since under
‘United States Generally Accepted Accounting Principles’ (hereinafter, GAAP), R&D
expenditures must be expensed instantaneously and therefore are well documented and
observable. Additionally, R&D expenditures could be effectuated reasonably quickly after
managerial decisions to invest or disinvest in innovation and are therefore clearly linked to
managerial intent to innovate. So, by its very nature, firm’s R&D expenditures have the
potential of producing a well-defined causal relation between governance provisions and
innovation efforts.

3.2.1.3 Measuring of interaction effect: degree of internationalization

To examine whether internationalization moderates the entrenchment–innovation expenditure

relationship, this study estimates a measure of entrenchment that is weighted by the degree of
internationalization. Prior theoretical contributions indicate that internationalization is a
multidimensional construct with multiple complexities in estimating a firms’ degree of
internationalization (Kotabe et al., 2002), and no consensus has emerged among researchers
regarding the measurement of degree of internationalization (Burgman, 1996).

This paper does not engage in the debate which measure of internationalization is superior, and
limits itself to one common measure of degree of internationalization, namely foreign income
ratio. Foreign income ratio is defined as foreign income in million dollars as a percentage of a
firm’s total income in million dollars (Sullivan, 1994). This ratio is more appealing for
empirical estimations than other widely used proxies for internationalization based on foreign
sales. This is because foreign sales also incorporate exports from the firms to foreign trade
partners. Therefore using foreign sales based measures could potentially combine a firm’s
international trade with the degree of internationalization (Bae and Noh, 2001). Thus, to

13
overcome the potential mixture of trade and internationalization, and to further ensure
robustness of internationalization results, this paper uses foreign income ratios as a proxy for
internationalization.

3.2.1.4 Control variables

This study also controls for other variables that may affect the relation between managerial
entrenchment and R&D. Three firm specific variables which previous research indicate that
could be related to R&D are examined. First, previous contributions show that controlling for
firm size is crucial, because it suggested that larger firms have lower returns on innovation
(Humphery-Jenner and Powell, 2011). It is argued, that smaller firm structures are better
adapted to an innovative perspective and have higher tolerance of risk taking behavior
(Holmstrom, 1989). Therefore, firm size could affect management’s efforts to invest in R&D.
This present paper includes firm size measured by the natural logarithm of total assets in million
dollars to control for these size effects, and expects firm size to be negatively related to
innovation. Second, previous literature indicate that a firm’s operating performance may also
influence innovation. For example, Eberhart, Maxwell, & Siddique (2004) argue operating
returns are positively related to innovation performance. Therefore, firms with higher operation
performance might be prone to invest more in innovation than firms with lower operating
performance. This paper includes return on assets (ROA), defined as operating income in
million dollars dived by total asset in million dollars, as a control measure of firm operating
performance. The expectation is that return on assets is positively related to R&D. Third,
previous literature suggests that financial constraints resulting from interest and principal
payment of debt, may force management to forsake profitable investment (Tallman and Li,
1996). Therefore, firms with higher debt may invest less in promising R&D projects than firms
with lower debt. This paper includes leverage measured by book value of long-term debt over
total value of the assets (in millions of dollars) to control for financial constraints, and expect
leverage to be negatively related to R&D expenditures.

3.2.2 Empirical methodology

Preceding the panel regression analysis, the appropriate estimation technique for the panel data
must be selected. This paper first test by means of the Breusch-Pagan Lagrange multiplier (LM)
whether a pooled ordinary least squares or a random/fixed effects model must be selected. The
null hypothesis in the LM test is that the data contains no panel data effect. That is, no

14
significant difference across firm’s could be observed. The null is rejected (Prob > F = 0.000 <
0.05), thus the sample contains a panel data effect and either a random or fixed effects model
is selected.

Thereafter, the current paper conducts the Hausman-test to decide whether the fixed or random
effects model is more appropriate estimation technique. Whereas the null hypothesis is that the
random effects model must be selected versus the alternative hypothesis that the fixed effects.
The Hausman-test essentially controls whether the unique errors are uncorrelated with the
regressors, against the alternative that the unique errors are correlated with the regressors. The
null hypothesis is rejected (Prob > F = 0.0462 < 0.05), thus the errors are correlated and the
fixed effects model is applied.

Finally, it controls for the presence of time fixed effects in the fixed effect model by means of
the Chow-test. The Chow-test jointly tests an auxiliary regression with a dummy variable for
all years, controlling for time-variation within the parameters and specifying whether the
parameters have changed once during the sample. In this sample the Chow-test rejects the null
hypothesis that the coefficients for all years are jointly equal to zero (Prob > F = 0.0174 < 0.05),
therefore time fixed effects are applied in this study. Results of the three tests indicate that fixed
time and entity effect model is the appropriate estimation technique. A comparison between
different estimation techniques is provided in Appendix III.1. The results of Breusch-Pagan
Lagrange multiplier, Hausman test, and Chow-test are provided in appendix III.2 to appendix
III.4.

To control whether the models used produce the most efficient ordinary least squares regression
estimation auxiliary test on the residual are performed. Following the Gauss-Markov
assumptions, this paper controls for heteroscedasticity and autocorrelation. Output results of
both tests are provided in appendix IV.1 and appendix IV.2. First, the White’s test for
heteroscedasticity is conducted to control whether the errors terms in the ordinary least squares
regression have a constant variance and whether the variance changes over time. Under the null
hypothesis, the error term is homoscedastic, and the alternative hypothesis states that the error
term is heteroscedastic. For the studied sample the null hypothesis is rejected (Prob > F =
0.000), thus the error term is heteroskedastic and the variance of the residuals can be explained
by the model’s regressors. To ensure the robustness of the standard errors, the White’s
heteroscedasticity robust standard error estimates are employed.

15
Second, Wooldridge test for autocorrelation in panel data is conducted to control whether there
are patterns in the error terms. Under the null hypothesis, the error term has no first order
autocorrelation, and the alternative hypothesis states that the error term has first order
autocorrelation. For the studied sample the null hypothesis is rejected (Prob > F = 0.000), thus
the error term has first order autocorrelation (i.e. there are patterns in the error terms). To ensure
the robustness of the standard errors, the standard errors are corrected with the Newey-West
HAC (heteroscedasticity and autocorrelation consistent standard) procedure.

3.2.3 Model estimation

To test Hypotheses 1a and 1b, the current paper employs a fixed time and entity effect model
that controls for the relationship between two defined R&D ratios and managerial entrenchment
and other control variables. The models’ variables and their definitions are discussed in
appendix I.

!&# %&'(&)%'*+,-
= 𝛽 𝐸𝑁𝑇𝑅%,'89 + 𝛽 𝑆𝐼𝑍𝐸%,'89 + 𝛽 𝑅𝑂𝐴%,'89 + 𝛽 𝐿𝐸𝑉%,'89 + α% + 𝜆' + 𝑢%,'
!&# )./()0,1

[Equation 1]

Where:

𝑅&𝐷 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦%,' or 𝑅&𝐷 𝑠𝑎𝑙𝑒𝑠%,' are the dependent variables, where i = entity and t = time.
𝛽 𝐸𝑁𝑇𝑅%,'89 represents the independent variable of managerial entrenchment
𝛽 𝑆𝐼𝑍𝐸%,'89 represents the control variable of firm size
𝛽 𝑅𝑂𝐴%,'89 represents the control variable of firm return on assets
𝛽 𝐿𝐸𝑉%,'89 represents the control variable of firm leverage
α% represents the entity fixed effect
𝜆' represents the time fixed effect
𝜇%' represents the error term

To test Hypotheses 2a and 2b, this paper first employs a model that examines the relationship
between the R&D ratios, managerial entrenchment and the firm internationalization. A third
model subsequently tests whether internationalization has a moderating effect with
incorporation of all control variables.

16
 !&# %&'(&)%'*0,1
= 𝛽 𝐸𝑁𝑇𝑅%,'89 + 𝛽 𝐼𝑁𝑇𝐸𝑅 %,'89 + 𝛽 𝑆𝐼𝑍𝐸%,'89 + 𝛽 𝑅𝑂𝐴%,'89 + 𝛽 𝐿𝐸𝑉%,'89 +
!&# )./()0,1

𝛼% + 𝜆' + 𝑢%,'
[Equation 2]

!&# %&'(&)%'*0,1
= 𝛽 𝐸𝑁𝑇𝑅%,'89 + 𝛽 𝐼𝑁𝑇𝐸𝑅 %,'89 + 𝛽 𝐸𝑁𝑇𝑅%,'89 ∗ 𝛽 𝐼𝑁𝑇𝐸𝑅%,'89 + 𝛽 𝑆𝐼𝑍𝐸%,'89 +
!&# )./()0,1
𝛽 𝑅𝑂𝐴%,'89 + 𝛽 𝐿𝐸𝑉%,'89 + 𝛼% + 𝜆' + 𝑢%,'

[Equation 3]
Where:
𝛽 𝐼𝑁𝑇𝐸𝑅%,'89 represents the independent variable of firm internationalization
𝛽 𝐸𝑁𝑇𝑅%,'89 ∗ 𝛽 𝐼𝑁𝑇𝐸𝑅%,'89 represents the interaction variable of firm entrenchment and firm
internationalization

Equivalently, the entity and time fixed effects regression model can be written in terms of a
least squares dummy variable regression model with inclusion of a single intercept. The
specifications of the rewritten time and firm fixed regression models that is utilized for further
estimation is discussed in appendix V3.

4. Results
4.1 Descriptive statistics
Table 1: Descriptive statistics and correlations.

Variable No of Mean Min Max Std dev. 1 2 3 4 5 6 7 8 9 10

Obs.

1. R&D intensity 3,530 0.051 0 0.601 0.057 1

2. R&D sales ratio 3,530 0.075 0 3.358 0.109 0.779*** 1

3. Managerial entrenchment 3,530 3.535 0 6 1.067 -0.022 -0.022 1

4. Dummy staggerd board and poison pill 3,530 0.124 0 1 0.330 0.0611*** 0.0385* 0.498*** 1

5. Dummy golden parachute and poison pill 3,530 0.158 0 1 0.364 0.014 0.018 0.474*** 0.586*** 1

6. Internationalization 3,530 0.486 -56.981 83.026 3.242 0.007 0.013 -0.011 0.004 0.004 1

7. Managerial entrenchement * internationalization 3,530 1.678 -184.321 249.077 10.701 0.008 0.014 0.032 0.031 0.030 0.974*** 1

8. Firm size 3,530 3.405 1.759 5.902 0.691 -0.253*** -0.142*** -0.163*** -0.142*** -0.107*** 0.032 0.023 1

9. Return on assets (ROA) 3,530 0.057 -1.541 0.783 0.096 -0.133*** -0.183*** -0.024 -0.019 -0.011 -0.010 -0.012 0.138*** 1

10. Firm leverage 3,530 0.193 0 1.929 0.177 -0.016 -0.026 0.0588*** 0.033 0.028 -0.009 -0.005 0.030 -0.0336* 1

See Appendix I. for variable definitions. * p<0.05, ** p<0.01, *** p<0.001

3
For all models of R&D intensity the measurement of internationalization variable and the interaction effect is based on the INTERrdi, while
for all models of R&D sales the measurement of internationalization and the interaction effect is based on the INTERrds. Definitions of all
proxies could be found in Appendix table I.

17
Table 1 displays the descriptive statistics of the characteristics of the 627 firms examined in
this study. Table 1 indicate that the firms in the sample, on average, adopt 3.54 governance
provisions and have yearly R&D investments equal to 5.10 per cent of firm’s book value of the
assets. Similarly, it is depicted that the sample firms obtain on average 48.6 per cent of firm’s
total income from foreign operations. Additionally, from the frequency statistics in table 2, it
could be observed that the adoption of governance provisions is a widely-spread practice for
the U.S. firms in the sample, for example 99.83 per cent of firms adopt at least 1 provision
whereas 34.03 per cent adopts the median of 3 governance provisions. The frequencies of
observed normal distributed E-scores (Shapiro-Wilk W test for normality prob. > Z = 0.063) is
graphically depicted in figure 1.

Table 2: Frequency score table E-scores with per centages

Figure 1: The frequencies of observed normal distributed E-scores
1500

E-score Frequency Per cent Cumulative

0 6 0.170% 0%

1 69 1.955% 2%
1000

2 482 13.650% 16%

Frequency

3 1,201 34.020% 50%

500

4 1,106 31.330% 81%

5 577 16.350% 97%

6 89 2.521% 100%
0

0 2 4 6
E-Score
Number of Firms 627
Total No. Of
3,530
observations

From the correlation matrix reported in table 1, it could be observed that the independent
variables of managerial entrenchment, internationalization and the moderating interaction
factor exhibit no significant correlation with the dependent variables R&D intensity and R&D
sales. This is derived from the Pearson correlation coefficient, that ranges from 1 to +1. This
result indicates no clearly distinguishable trend between the regressors and the dependent
variable. Confirming this paper’s predictions, the correlation matrix in table 1 shows that two
control variables, respectively firm size and firm ROA show a weak to moderate negative
correlation with R&D intensity and are statistically significant.

18
4.2 Results fixed time and entity effect regression models

Table 3 presents three fixed time and entity effect models that control for the hypothesized
relationships. The R-squared from all models indicate that the explanatory power of the
independent variables on R&D intensity ratio is superior to the explanatory power of the
independent variables on R&D sales ratio. Therefore, the interpretation and discussion of the
results will be merely focused on the models that explain the dependent variable of R&D
intensity.

Table 3: Regression results time and entity fixed effect models

RDI RDS

Variable Model 1 Model 2 Model 3 Base model Model 1 Model 2 Model 3 Base model

Managerial entrenchment 0.00140** 0.00141** 0.00132* 0.00132* 0.000830 0.000822 0.000952 0.000952
(0.000696) (0.000696) (0.000717) (0.000717) (0.00140) (0.00142)(0.00133) (0.00133)
Internationalization 0.000109 -0.000595 -0.000595 -8.13e-050.00100 0.00100
(0.000124) (0.000973) (0.000973) (0.000213)
(0.00121) (0.00121)
Entrenchment * 0.000216 0.000216 -0.000333 -0.000333
(0.000311) (0.000311) (0.000414) (0.000414)
Firm size -0.0242*** -0.0243*** -0.0244*** -0.0244*** -0.00219 -0.00209 -0.00195 -0.00195
(0.00790) (0.00791) (0.00792) (0.00792) (0.0147) (0.0148) (0.0148) (0.0148)
Firm leverage -0.0142** -0.0141** -0.0142** -0.0142** -0.0492*** -0.0492*** -0.0492*** -0.0492***
(0.00558) (0.00558) (0.00559) (0.00559) (0.0168) (0.0168) (0.0167) (0.0167)
Return on assets (ROA) 0.00563* 0.00571* 0.00565* 0.00565* 0.00353 0.00347 0.00356 0.00356
(0.00309) (0.00310) (0.00309) (0.00309) (0.00541) (0.00544) (0.00542) (0.00542)

2009 -0.00628*** -0.00631*** -0.00630*** -0.00630*** -0.00372 -0.00370 -0.00372 -0.00372

(0.00215) (0.00215) (0.00215) (0.00215) (0.00374) (0.00374) (0.00374) (0.00374)
2010 -0.00823*** -0.00823*** -0.00827*** -0.00827*** -0.00504 -0.00504 -0.00498 -0.00498
(0.00226) (0.00226) (0.00227) (0.00227) (0.00703) (0.00703) (0.00709) (0.00709)
2011 -0.00607*** -0.00608*** -0.00602*** -0.00602*** -0.00959** -0.00958** -0.00967** -0.00967**
(0.00201) (0.00201) (0.00200) (0.00200) (0.00420) (0.00419) (0.00424) (0.00424)
2012 -0.00443** -0.00444** -0.00441** -0.00441** -0.00644* -0.00643* -0.00648* -0.00648*
(0.00202) (0.00202) (0.00201) (0.00201) (0.00387) (0.00386) (0.00390) (0.00390)
2013 -0.00349* -0.00351* -0.00349* -0.00349* -0.00286 -0.00285 -0.00287 -0.00287
(0.00205) (0.00205) (0.00205) (0.00205) (0.00370) (0.00368) (0.00368) (0.00368)
2014 -0.00255 -0.00254 -0.00251 -0.00251 -0.00185 -0.00186 -0.00190 -0.00190
(0.00214) (0.00214) (0.00214) (0.00214) (0.00299) (0.00300) (0.00301) (0.00301)
2015 -0.00283 -0.00282 -0.00280 -0.00280 -0.00284 -0.00285 -0.00288 -0.00288
(0.00217) (0.00217) (0.00217) (0.00217) (0.00341) (0.00342) (0.00345) (0.00345)
2016 -0.00288 -0.00286 -0.00282 -0.00282 -0.00127 -0.00128 -0.00135 -0.00135
(0.00224) (0.00224) (0.00224) (0.00224) (0.00439) (0.00442) (0.00447) (0.00447)
Constant 0.132*** 0.132*** 0.133*** 0.133*** 0.0850* 0.0847* 0.0838* 0.0838*
(0.0267) (0.0267) (0.0268) (0.0268) (0.0479) (0.0481) (0.0483) (0.0483)

Observations 3,530 3,530 3,530 3,530 3,530 3,530 3,530 3,530

Number of firms 627 627 627 627 627 627 627 627
R-squared 0.040 0.041 0.042 0.042 0.008 0.008 0.008 0.008
Adj. R-squared 0.0371 0.0372 0.0378 0.0378 0.0045 0.0043 0.0042 0.0042
Newey-West Standard robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

The beta coefficient of entrenchment in model 1 indicate that R&D intensity ratio increases
with one per mille when E-score increases by one. On that premise, the model suggests that this
causal link between entrenchment and R&D intensity is significant on 5 a per cent confidence
interval. However, the size-effect is so small (one per mille), that the effect does not appear to
be practically relevant. Furthermore, results of model 2 indicate that beta coefficient of
internationalization has a very small, one per ten mille, non-significant effect on R&D intensity

19
when holding all the other independent variables constant. Model 3 produces a non-significant
beta coefficient regarding the interaction effect of two per ten mille. Hence, no statistical
support is found that the hypothesized internationalization interaction effect significantly
moderates the entrenchment–R&D intensity relationship, holding all the other independent
variables constant.

All R&D intensity models show to have a R-squared of 4.2 per cent or lower. The R-squared
explains the fraction of the variation in R&D intensity that is accounted for by the regressors.
In addition, this paper considers the adjusted R-squared. The advantage of the adjusted R-
squared is that it resolves various problems associated with the regular R-squared, but more
importantly the adjusted R2 penalizes the model for insertion of additional independent
variables. All models R-squared are between 3.7 and 3.8 per cent. This indicates that the
practical implications and the generalizability of the results should take into account the limited
explanatory power of the models.

4.3 Robustness checks and further analyses

In this section, this paper performs additional analysis and robustness checks to control whether
the primary findings are affected by applying alternative measures and it addresses the potential
concerns of endogeneity.

4.3.1 Controlling for unequal potency of governance provisions

Bebchuk et al. (2008) indicate that governance provisions are not equally potent for deterring a
change in control, whilst Danielson and Karpoff (2006) show that some combinations of
governance provisions are more frequently used than others. Bebchuk and Cohen (2005) state
that the combination of two governance provisions, namely a staggered board with a poison
pill, is especially highly effective as deterrents for hostile acquisition attempts. Moreover,
Bebchuk et al. (2008) describe that poison pills and golden parachutes are specifically designed
to heighten the costs of hostile acquisition attempts. Therefore, these specific governance
provisions impair one of the strongest governance mechanisms to discipline managers to pursue
innovation (Atanassov, 2013). This paper tests whether the presence of the described
combinations of governance provisions exerts additional influence on the predicted
relationships between managerial entrenchment and investments R&D.

20
To do so, this paper employs two additional models with dummy variables to capture the effect
of the described combinations on the relationship between managerial entrenchment and
investments in innovative activities. This is reflected by the fourth regression model, that
controls for whether the presence of the combination of staggered board with poison pill and
the fifth regression model that that controls for the presence of the combination of golden
parachutes with poison pill. The models’ variables and their definitions are discussed in
appendix I.

!&# %&'(&)%'*0,1
!&# )./()0,1
= 𝛽 𝐷𝑠𝑝𝑖,𝑡−1 + 𝛽 𝑆𝐼𝑍𝐸𝑖,𝑡−1 + 𝛽 𝑅𝑂𝐴𝑖,𝑡−1 + 𝛽 𝐿𝐸𝑉𝑖,𝑡−1 + α𝑖 + 𝜆𝑡 + 𝑢𝑖,𝑡

[Equation 4]
!&# %&'(&)%'*0,1
!&# )./()0,1
= 𝛽 𝐷𝑔𝑝𝑖,𝑡−1 + 𝛽 𝑆𝐼𝑍𝐸𝑖,𝑡−1 + 𝛽 𝑅𝑂𝐴𝑖,𝑡−1 + 𝛽 𝐿𝐸𝑉𝑖,𝑡−1 + α𝑖 + 𝜆𝑡 + 𝑢𝑖,𝑡

[Equation 5]
Where,
𝑅&𝐷 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦%,' or 𝑅&𝐷 𝑠𝑎𝑙𝑒𝑠%,' are the dependent variable, where i = entity and t = time.
1 when both staggerd board and poison pill provisions are present
𝐷𝑠𝑝%,'89
0 𝑂𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒
1 when both golden parachute and poison pill provisions are present
𝐷𝑔𝑝%,'89
0 𝑂𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒

Table 4 shows that in contrast to model 1, the beta coefficients in the models 4 and 5 become
insignificant for the relationship between the dummy variables and R&D intensity. However,
from the test of unequal beta’s, this paper concludes that no substantial evidence is found for
the proposition that the presence of the described governance provisions produce significant
different results than the E-index as a whole.

21
 Table 4: Regression results further analysis and robustness check

RDI

Variable Model 1 Model 4 Model 5

0.00140**
Managerial entrenchment
(0.000696)
0.00181
Dummy staggered board and poison pill
(0.00277)
0.000854
Dummy golden parachute and poison
pill (0.00216)
-0.0242*** -0.0239*** -0.0239***
Firm size
(0.00790) (0.00792) (0.00786)
-0.0142** -0.0141** -0.0140**
Firm leverage
(0.00558) (0.00561) (0.00562)
0.00563* 0.00576* 0.00579*
Return on assets (ROA)
(0.00309) (0.00316) (0.00314)

2009 -0.00628***-0.00655*** -0.00654***

(0.00215) (0.00220) (0.00213)
2010 -0.00823***-0.00785*** -0.00803***
(0.00226) (0.00226) (0.00225)
2011 -0.00607***-0.00564*** -0.00584***
(0.00201) (0.00205) (0.00197)
2012 -0.00443** -0.00394* -0.00416**
(0.00202) (0.00207) (0.00196)
2013 -0.00349* -0.00308 -0.00331*
(0.00205) (0.00206) (0.00197)
2014 -0.00255 -0.00228 -0.00252
(0.00214) (0.00217) (0.00209)
2015 -0.00283 -0.00261 -0.00285
(0.00217) (0.00221) (0.00213)
2016 -0.00288 -0.00275 -0.00300
(0.00224) (0.00229) (0.00222)
Constant 0.132*** 0.135*** 0.136***
(0.0267) (0.0272) (0.0267)

Observations 3,530 3,530 3,530

Number of firms 627 627 627
R-squared 0.040 0.039 0.039
Adj. R-squared 0.0371 0.0355 0.0352
Newey-West Standard robust standard errors in parentheses:
*** p<0.01, ** p<0.05, * p<0.1

4.3.2 Concerns of endogeneity

One of the major issues in empirical corporate finance studies is the concern of endogeneity,
that is, broadly defined as a correlation between the explanatory variables and the error term in
a regression (Roberts and Whited, 2013). Through an econometric lens, endogeneity is an issue
in a panel dataset when there is a violation of one or more out of three assumptions. Namely,
the sample has no omitted variables bias, the sample has no measurement error or the sample
has no reverse causality. By adopting the fixed effects model this paper controls for all time-
invariant differences between the firms, so the estimated coefficients of the fixed-effects models
cannot be biased because of omitted time-invariant characteristics. Therefore, the fixed effect
model approach offers a remedy to the endogeneity concern of omitted variable bias.
Furthermore, considering the potential measurement error, this paper is confident that
the measurements used are comprehensively described and concisely applied. Addressing
another common panel data concern regarding the simultaneous occurrences of changes of
between variables and possible biases introduced by reverse causality, this paper follows a
similar approach as Phillips and Zhdanov (2012), and scales the dependent variable R&D

22
intensity and R&D sales ratio at time t whilst all independent and control variables are scaled
at time t−1.

5. Conclusion and discussion

Corporate governance mechanisms exist to safeguard the responsible governance of firms, by
both management and shareholders. One aspect of corporate governance is to protect against
short term opportunism that may be harmful to a firm on the long-term. Firms and shareholders
employ governance provisions to obtain this goal, and in this study are observed to be very
widely used. Given the high prevalence of governance provisions, research into their effect on
firm’s performance is highly relevant. Shareholder value is a common proxy for firm
performance, however it represents a high level of abstraction, providing little insight into the
underlying performance drivers of the firm.

Therefore, this study looks at a crucial pillar for long-term firm performance, that is R&D
(Chakraborty et al., 2014). Firms that do not invest in R&D tend to lose their competitive
advantage over time (Atanassov, 2013; Chemmanur and Tian, 2018). Moreover, the present
paper reports a significant portion (± 5 per cent) of firm value to be allocated to R&D
expenditures. Notwithstanding the relative size and importance of R&D investments, it is
widely argued that the separation of ownership and control may induce both shareholders and
managers to shirk away from investments in R&D (Holmstrom, 1989; Meulbroek et al., 1990).
This is caused by the nature of R&D investments, since it is a present-day effort with uncertain
results in the future. Therefore, R&D investments are likely target to be replaced by short-term
opportunistic activities. Governance provisions are believed to serve as a tool to counteract this
opportunism. This study endeavours to investigate if this perceived effect can be observed in a
large sample of U.S. firms.

Firms in the modern economy are highly internationalized as illustrated by the high percentage
of foreign income in this study (± 49 per cent). In contrast with past era’s, modern firms have
globalized to such a degree that the isolated domestic perspective in finance research is no
longer suitable. The factor of internationalization is therefore of fundamental importance when
studying the effect of governance provisions on R&D investments. This led to the main question
of this study: What effect do governance provisions have on investments in innovation, and is
this effect moderated by firm internationalization?

23
Two theoretical strands of literature were identified through which the relationship between
entrenchment and R&D investment may be viewed. Regression results suggest that the effect
of entrenchment on R&D intensity is significant and positive. However, the size-effect is so
small (one per mille), that the effect does not appear to be practically relevant. Thus, the absence
of a concrete effect of governance provisions on R&D intensity calls into question the relevance
of this specific corporate governance mechanism framework in the U.S. context. In addition,
this paper finds no significant moderating interaction effect of internationalization on the
entrenchment-R&D relationship. Therefore, this paper’s findings suggest that proposed effects
of internationalization do not modify the relationship between entrenchment and R&D for U.S.
firms.

In addition, various robustness checks on the regression models do not significantly alter the
primary findings. Subsamples with respect to specific industries, time periods, firm size and
operational performance of firms produced results in line with the primary findings for all
hypothesis. Further robustness checks indicate that the presence of the governance provisions
combinations of a staggered board and poison pill (Bebchuk and Cohen, 2005) or governance
provisions combination of a golden parachute and poison pill (Bebchuk et al., 2008) do not
produce statistically different results than the E-index as a collective. Therefore, the unequal
influence of these provisions could not be observed, thus, this study further confirms the
robustness of the E-index within the context of R&D investments for U.S. firms. Furthermore,
this papers results support Danielson and Karpoff (2006) findings that some governance
provisions and some combinations of governance provisions are more frequently used than
others. Therefore, confirming the unequal frequency of specific governance provisions within
the index for this studies time-period between 2008-2016 for U.S. firms. In appendix VI a
graphical representation of the observed frequencies of governance provisions is provided.

A possible explanation for the non-reproducibility of prior empirical support for either the
entrenchment or the myopia hypothesis may be attributed to alterations in the U.S firm’s
business environment. In contrast to most other studies, this paper is set during and directly
after the 2007-2008 collapse of the global banking system. Many argued that this crisis was
provoked by shortcomings in corporate governance practices by U.S. firms, and as a response
scholars, legislators and practitioners felt compelled to re-evaluate existing corporate
governance mechanisms. This re-evaluation as a response to the financial crisis could have
fundamentally changed the role of corporate governance mechanisms and governance
provisions in particular. This is supported by the observation that in the midst-crisis years

24
between 2007 and 2010 a steep increase of the average adoption of governance provisions could
be observed succeeded by a post-crisis gradual decrease and return to pre-crisis level between
2009 and 2016. The E-score heterogeneity across years is depicted in appendix VII. Thus, the
non-reproducibility of prior results may be explained by post-crisis changes to corporate
governance mechanisms employed by firms. The results from this paper suggest that
succeeding studies could contribute by exploring qualitatively how different corporate
governance mechanisms are interrelated, and how they develop over time. It could further the
comprehension of corporate governance to quantify these complementary governance
mechanisms and compare the prior-crisis framework with the post-crisis framework.

Another difference between this study and most previous research is that it examines R&D
intensity instead of R&D performance measures. The strength of applying R&D intensity as a
proxy for innovation is that it reflects managerial intention to innovate. Compared to outcome
measures (e.g. number of patents and number of patents citations) which are dependent on
success of the investments, it is a more appropriate measure for managerial intentions. This is
suitable when studying the nexus between managerial incentives and R&D intensity (Hoskisson
et al., 1993; Lhuillery, 2011; Vithessonthi and Racela, 2016), but a downside may be that the
difference in approach here could obstruct the generalizability and comparison of findings
based on outcome measures (Atanassov, 2013; Becker-Blease, 2011; Chakraborty et al., 2014)
to R&D intensity based inferences.

Further this study acknowledges some limitations regarding its measurement of variables,
sample selection, and econometrical procedures. First, the author recognizes that R&D intensity
might be an imperfect measurement of managerial intent to innovate. This because financial
reporting of R&D expenditures is at the discretion of management and U.S GAAP accounting
standards permits different interpretations for recognizing and reporting R&D expenditures on
intangible assets (IAS 38). As a result, observed R&D intensities may be subjected to
managerial manipulation of reported financial results. Secondly, missing data resulting from
imperfect data coverage of S&P 1500 firms by the Compustat Capital-IQ database, may
introduce an undocumented overrepresentation of certain types of firms. Considering that the
statistical software package selected the final sample (containing 27 per cent of base sample)
based on sufficient data availability, firms with less coverage by Compustat Capital-IQ database
may be underrepresented in the final sample. Multiple reasons differences in data availability
could be suggested, namely that a firm’s degree of disclosure is contingent to certain industries

25
dynamics, geographic locations differences or other firm specific characteristics. Therefore, it
might be the case that firms with characteristics that are associated with higher corporate
disclosure are overrepresented in the final sample. Third, this paper employs a fixed effect
model and controls for unanticipated time effects. The upside of this approach is that the fixed
effect model is superior over the random effect model for explaining inferences within the
sample. However, by adopting the fixed effect, this paper has limited generalization power for
the results beyond the sample. Notably, the result of the Hausman-test (see appendix III.1) are
only borderline in favor of the fixed effects model. Thus, generalizability of this paper’s
conclusions must be considered with caution.

All in all, this study’s findings cast doubt on the existence of a relationship between governance
provisions and R&D intensity for U.S. S&P 1500 firms. It is conceivable that the two
diametrically opposing effects as proposed in the entrenchment view and myopia view coexist
and exert equally weighted effects, cancelling each other out. This might explain why the
effects of the entrenchment on R&D are close to zero in this study.

The second, and most central, hypothesis of this study proposed a moderating effect of
internationalization. This proposed effect was not observed in the current data analysis. The
measurement of foreign income as internationalization variable ensures clear demarcation and
distinction between domestic and internationalized firms. However, it is not a very fine grained
measure with regard to the distribution of foreign income across different foreign countries.
Possibly the degree of institutional difference, a term used to describe the differences between
local economic systems, must be taken into consideration. Foreign income as proxy for
internationalization does not further specify such distance between countries, and therefore, this
measure restricts the current paper in analyzing the differences in institutional distance between
the U.S. and foreign countries where the income is obtained. Further research could address
this void, by incorporation of one or multiple international business research variables that
capture the institutional distance between countries. Academics within the international
business stream often argue that larger institutional distances would impose larger effects on
internationalization performance. Also, other non-financial proxies of internationalization (e.g.
multinationalism of boards and number of foreign subsidiaries) could help further substantiate
the concept of firm internationalization.

26
This paper could be a stepping stone towards a better theoretical and practical understanding of
how corporate governance practices influence decision-making of innovation for
internationalized firms. To the author’s best knowledge, however, no data is currently available
to researchers for non-U.S. firms on the Bebchuk et al., (2008) inspired E-index. Therefore, it
is still largely unknown how governance provisions affect corporate governance and innovation
outside the U.S domicile. It would be fascinating to gather this data and compare the effects
governance provisions around the globe.

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32
Appendices

Appendix I: Variables and definitions.

Variable Definition

Dependent variables
R&D intensity RDI R&D expenditures / total book value of the assets

R&D sales ratio RDS R&D expenditures / total sales

Independent variable
Managerial entrenchment ENTR E-Score measured scaling from 1 to 6, lagged by 1 year

1 $ℎ&' ()*ℎ +*,--&./ (),./ ,'/ 0)1+)' 0122 ,.& 0.&+&'*

Dummy variable for measuring presence combination staggerd board and poison pill DSP Dummy variable lagged by 1 year !
0 )*ℎ&.$1+&

Dummy variable for measuring presence combination golden parachute and poison pill DGP Dummy variable lagged by 1 year !1 $ℎ&' ()*ℎ -)2/&' 0,.,4ℎ5*& ,'/ 0)1+)' 0122 ,.& 0.&+&'*
0 )*ℎ&.$1+&
Firm internationalization RDI INTERrdi Internationalization measured by Foreign income ratio:foreign income / total income, lagged by 1 year

Firm internationalization RDS INTERrds Internationalization measured by Foreign sales ratio:foreign sales / total sales lagged by 1 year

Moderating variable
Degree of Internationalization (DOI) ENTR * INTER E-Score measured scaling from 1 to 6, lagged by 1 year multiplied by
Foreign sales ratio measured by foreign income / total income, lagged by
Control variables
Firm size SIZE Natural logarithm of total assets, lagged by 1 year

Firm leverage LEV Book value of total debt / total assets, lagged by 1 year

Return on assets (ROA) ROA Operating income / total assets, lagged by 1 year

Appendix II: ISS Governance Database definitions of the six Provisions within Bebchuck et al., (2008) E index

Variable Definition

Staggered board a board in which directors are divided into separate classes (typically three) with each class being elected
to overlapping terms.

Limitation on amending bylaws a provision limiting shareholders' ability through majority vote to amend the corporate bylaws.

Limitation on amending the charter a provision limiting shareholders' ability through majority vote to amend the corporate charter.

Supermajority to approve a merger a requirement that requires more than a majority of shareholders to approve a merger (=> 66.66 per cent)

Golden parachute a severance agreement that provides benefits to management/board members in the event of firing,
demotion, or resignation following a change in control

Poison pill a shareholder right that is triggered in the event of an unauthorized change in control that typically renders
the target company financially unattractive or dilutes the voting power of the acquirer.

33
 Appendix III.1 Comparing different linear regression models

Dependent variable: RDI

OLS With Firm fixed Firm and
Variable dummies effects time fixed
Managerial entrenchment -0.00347*** 0.00103 0.00134*
(0.000907) (0.000695) (0.000718)
Internationalization -0.000223 -0.000569 -0.000594
(0.00238) (0.000978) (0.000972)
Entrenchment * Internationalization 0.000144 0.000205 0.000216
(0.000785) (0.000312) (0.000310)
Firm size -0.0209*** -0.0188*** -0.0242***
(0.00125) (0.00634) (0.00791)
Firm leverage -0.0596*** -0.0105* -0.0145***
(0.0132) (0.00537) (0.00559)
Return on assets (ROA) -0.00308 0.00485 0.00554*
(0.00534) (0.00305) (0.00308)
Constant 0.138*** 0.111*** 0.132***
(0.00608) (0.0214) (0.0267)

Observations 3550 3550 3550

R-squared 0.081 0.024 0.041
Number of firms 2323 627 627
Firm FE YES YES
Year FE YES

Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

Appendix III.2 Breusch and Pagan Lagrangian multiplier test for random effects

Estimated results:

Variance Std dev. H0: Var(u) = 0

RDI 0.0032522 0.0570279 H1: Var(u) ≠ 0
e 0.0002846 0.0168693 Chibar^2 = 7829.08
u 0.0029963 0.0547384 Prob > Chibar^2 = 0.000

34
 Appendix III.3 Hausman fixed random effect test

Coefficients

b-B
FE estimator (b) RE estimator (B ) difference

Managerial entrenchment 0.0010252 0.0008882 0.0001371 0.0001254

Internationalization -0.0005712 -0.0005171 -0.0000541 0.0000482

Entrenchment * Internationalization 0.0002053 0.0001892 0.0000162 0.0000136

Firm size -0.0191632 -0.0206265 0.0014633 0.0016887

Firm leverage -0.0101922 -0.0115436 0.0013514 0.0004872

Return on assets (ROA) 0.0049941 0.004739 0.0002551 0.0003444

H0: Difference in coefficients not systematic

H1: Difference in coefficients is systematic

Chi^2(6) = = 12.81
Prob>Chi^2 = 0.0462

Appendix III.4: Chow-test For Time

fixed-effects

2009 = 0
2010 = 0
2011 = 0
2012 = 0
2013 = 0
2014 = 0
2015 = 0
2016 = 0

F( 8, 626) = 2.34
Prob > F = 0.0174

Appendix IV.1: Modified Wald test for

groupwise heteroskedasticity in fixed effect
regression model

H0: σ(i)^2 = σ^2 for all i

H1: σ(i)^2 ≠ σ^2 for all i

Chi^2 (632) = 1.6e+35

Prob>Chi^2 = 0.000

35
 Appendix IV.2: Wooldrige test for
autocorrelation in panel data

H0 : no first order autocorrelation

H1 : first order autocorrelaion

F( 1, 490) = 526.126
Prob > F = 0.0000

Appendix V: Specification of rewritten time and firm fixed regression models utilized for further
estimation

𝑅&𝐷 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦%,' = 𝛼 + 𝛽9 𝑋%,'89 + ⋯ + 𝛽m 𝑋%,'89 + 𝛾o ∗ 𝐷o,% + ⋯ + 𝛾& ∗ 𝐷&,% + 𝛿o ∗ 𝐵o,' + ⋯ +

𝛿& ∗ 𝐵r,' + 𝑢%,'

𝑅&𝐷 𝑠𝑎𝑙𝑒𝑠%,' = 𝛼 + 𝛽9 𝑋%,'89 + ⋯ + 𝛽m 𝑋%,'89 + 𝛾o ∗ 𝐷o,% + ⋯ + 𝛾& ∗ 𝐷&,% + 𝛿o ∗ 𝐵o,' + ⋯ + 𝛿& ∗

𝐵r,' + 𝑢%,'

With n − 1 dummy variables and T − 1 binary variables whereas,

1 when i = 2 1 when i = n 1 𝑤ℎ𝑒𝑛 𝑡 = 2 1 𝑤ℎ𝑒𝑛 𝑡 = 𝑇

Do,t u ,..., Dw,t u & Bo,' u ,..., Br,' u
0 𝑂𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒 0 𝑂𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒 0 𝑂𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒 0 𝑂𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒
Where: 𝑅&𝐷 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦%,' or 𝑅&𝐷 𝑠𝑎𝑙𝑒𝑠%,' is the dependent variable where i = entity and t = time.
𝛽 𝑋%,'89 represents independent variables, up to 𝛽 𝑋𝑘%,'89
𝛼 represents the constant
𝛾o ,…, 𝛾& represents the coefficient for the binary entity regressors
do ,…, do represents is the coefficient for the binary time regressors
𝜇%,' represents the error term

36
 Appendix VI: Presence of E-index governance provisions for sample firms shown in percentages
100%
Percentage of firms that adopted an E-index governance provision

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
Classified Board Limit Ability to Amend Limit Ability to Amend Supermajority - mergers in Golden Parachutes Poison Pill Dummy Stag And Poison Dummy Golden And
ByLaws Charter percent Poison

Appendix VII: E-score heterogeneity across years

3.7 3.6
Mean E-Scores
3.5 3.4
3.3

2008 2010 2012 2014 2016

Year

37