Construction of a Firm Level Innovation Index and Assessment of its Impact on Stock Market Performance

Abstract

This study measures innovation outcomes within a firm by constructing a composite index. The composite index is constructed by relying on firm level data that is official and publicly available. The constructed composite index treats innovation as a holistic process that is comprised of three inter-related stages inputs, throughputs, and outputs. It is recognized that innovation may occur across each of these stages inside a firm. To this end, a comprehensive theoretical framework is expounded after a thorough review of existing literature. The reliance of this index on reliable and publicly available sources of information makes it suitable for a wide range of internal as well as external stakeholders who typically do not have access to the inner workings of a firm including its innovation endeavours. Such stakeholders may include academic researchers, supply chain partners, research collaborators, management of competitive firms, and industry-wide policy makers. The construction of the index followed an established six step process comprising of the following steps phenomenon definition, indicator selection, normalization, weighting of the normalized indicators, aggregation of the normalized indicators, and validation of the composite index. By theoretically viewing innovation as an encompassing conversion process but by relying on a manageable number of eight basic indicators for index construction, this study attempts to incorporate theoretical comprehensiveness and parsimony. The theoretical framework identified for this study is applicable across industrial contexts and for goods and/or service-oriented firms. A sample of SandP 500 firms was drawn, and innovation outcome data was collected for a ten-year period so that each firm in the sample was given a composite index score at the end of its fiscal year. Findings reveal that the theoretical framework is robust to choice of aggregation method and that the innovation index depicts a positive impact on abnormal stock returns as predicted by prior research