The Wealth Effect of New Product Introductions on Industry Rivals Presenters: 李曉玲 李欣恬 吳美奇

Introduction New product announcement effects related to the characteristics of the announcing firms, their industries, or the products themselves. The effects of new product announcements on the competitors: 1. Market expansion effect-Kodak Company v.s. Polaroid Corporation 2. Market substitution effect-In Focus Systems v.s. Sony Electronics Inc.

In our study, we examine new product announcements in 60 different industries based on four-digit Standard Industrial Classification(SIC) code. Collect a sample of 863 announcements of new product introductions from 1987 to We examine a broad list of potentially important factors that could explain the cross- sectional variation of the wealth effect of new product announcements on industry rivals. These factors include industry variables,firm variables, product variables and the announcement frequency. Introduction ﹙ Cont. ﹚

Results preview The average announcement-period abnormal return for the announcing firms is significantly positive.Rival firms experience a small but significantly negative share price response. Rivals in technologically based industries(such as pharmaceuticals preparation, computer and office equipment,semiconductors and so on) experience the most significantly unfavorable share price response.

Industry rivals ’ negative share price response is more pronounced when their firm size is smaller. Rival firms with better investment opportunities experience a more unfavorable wealth effect. Rival firms with higher financial leverage experience a more adverse wealth effect than do those with lower leverage. Vulnerability of leveraged firms in product market competition is more severe in concentrated industries. Rivals ’ share price response is significantly positively related to product newness. Results preview ﹙ Cont. ﹚

When the products introduces are of high newness, there is a greater likelihood of an accelerated market growth, which would benefit industry rivals. When the products introduced are simply updates of existing products, industry rivals would not benefit much from any potential market expansion. New product announcement made by frequent announcers indicate a more unfavorable wealth effect on industry rivals. Results preview ﹙ Cont. ﹚

A. Degree of Surprise ﹙ Cont. ﹚ Announcement frequency Firm typeAnnouncing firms Rival firms Effect?- Result 1.capitalize on follow-on investment 2.generate future investment opportunitie s 1.surprise is smaller: announcement s made by firms that have frequent product announcement

B. Industry Characteristics Degree of industry competition → market substitution effect Firm type Announcing firmsRival firms Effect+- Result the capacity to introduce new products faster and on time is likely to be an important source of differentiation and competitive advantage. experience lost sales, lower profits, and a loss of competitive advantage.

High-technology industry → market substitution effect B. Industry Characteristics ﹙ Cont. ﹚ Firm type Announcing firmsRival firms Effect+- Result The announcement- period abnormal return is greater for the most technologically based industries, such as computers chemicals, petroleum and so on. Lagged rival firms are likely to lose more competitive advantage.

C. Rivals ’ Firm Characteristics Firm size Firm type Announcing firms Rival firms Effect-- Resul t New products should be more highly valued for small firms than for large firms 1.large firms generally have a wider range of products. 2.information production and dissemination is a positive function of firm size.

Investment opportunities → market substitution effect C. Rivals ’ Firm Characteristics ﹙ Cont. ﹚ Firm type Announcing firms Rival firms Effect+- Result Firms with good investment opportunities are generally regarded as worthwhile 1.the market might be disappointed 2.the value of growth options could be impaired 3.market value ↓ :firms with better inv. opportunities

Free cash flow Firm type Announcing firms Rival firms Effect?- Result 1.agency cost 2.external financing provides monitoring 3.pecking order theory 1.market might be disappointed with their ability 2.market could even perceive that they divert their efforts to negative NPV projects C. Rivals ’ Firm Characteristics ﹙ Cont. ﹚

R&D intensity → market substitution effect Firm type Announcing firmsRival firms Effect+- Result1.seize some technological opportunities 2.seek for patent protection 1.at a competitive disadvantage 2.poorer share price response: High R&D intensity >low R&D intensity C. Rivals ’ Firm Characteristics ﹙ Cont. ﹚

Leverage Firm type Announcing firmsRival firms Effect?- Result1.agency cost 2.external financing provides monitoring 3.pecking order theory 1.lose market share 2.under-investment 3.unfavorable wealth effect:high debt level > low debt level 4.especially in concentrated industries C. Rivals ’ Firm Characteristics ﹙ Cont. ﹚

D. Product Announcement Type Product newness 1) market substitution effect

D. Product Announcement Type Product newness 2) market expansion effect

D. Product Announcement Type Single- or multiple-product announcement market substitution effect

D. Product Announcement Type Entry timing 1) market substitution effect

D. Product Announcement Type Entry timing 2) market expansion effect

Sample Sample period: 1987 – 1995 Sample condition: 1) firms listed on NYSE or AMEX 2) DJNRS database provides news-service articles and selected stories from WSJ, DJNW, and Barron ’ s 3) key words: introduce, new product, unveil, launch, received approval, to market, test market, begin selling

Sample Sample limit: 1) exclude those announcements by firms that have other announcements five days before and after the initial announcement date 2) exclude the announcements if there is no rival firm in the announcing firm ’ s industry 3) exclude the announcing firms or their rivals if they do not have data available from the CRSP returns files and the Compustat files 863 new product announcements by 158 different firms in 60 industries

Table 1 The announcements mainly come from four industries: 1) chemicals and pharmaceuticals 2) computers 3) electrical equipment and appliances 4) instruments and photographic equipment Firms in the computer and office equipment industry have the highest frequency of introducing new products.

chemicals & pharmaceuticals

computers electrical equipment & appliances Instruments & photographic equipment

Variable Measures

Degree of “ Surprise ” Announcement-Period Abnormal Returns (ACAR) 1) for the announcing and rival firms 2) standard event-study method 3) the difference between the actual return and an expected return generated by the market model Announcement Frequency (FREQ) the number of new product announcements made by an announcing firm over the sample period

Industry Characteristics Herfindahl Index (HI) 1) measure the degree of industry competition 2) the sum of the squared fraction of industry sales by all firms in the industry for the fiscal year prior to the announcement 3) 1, if an industry ’ s HI is greater than sample median 0, otherwise Dummy variable (HIGH TECH) 1, if the rival firms are in a high-technology industry 0, otherwise

Rivals ’ Firm Characteristics Firm size (Size) logarithm of book value of total assets for the fiscal year preceding the announcement Investment opportunities (Q) 1) the average q ratio for the three fiscal years prior to the announcement 2) q >1: high-q firms good investment opportunities q <1: low-q firms poor investment opportunities 3) 1, for high-q firms 0, for low-q firms

Rivals ’ Firm Characteristics Free cash flow (FCF) operating income before depreciation minus interest expense, taxes, preferred dividends, and common dividends, divided by book value of total assets, for the fiscal year preceding the announcement R&D intensity (RDI) R&D per dollar of sales for the fiscal year prior to the announcement

Rivals ’ Firm Characteristics Leverage (DEBT RATIO) the book value of total debt divided by the book value of total assets, for the fiscal year preceding the announcement Interaction variable (DEBT RATIO*HIGH HI) to test the interaction effect of debt level and industry concentration

Product Announcement Type Dummy variable (MULTIPLE) 1, for multiple-product announcements 0, for single-product announcements Dummy variable (TIME) 1, for announcing firm is the first mover 0, otherwise Dummy variable (NEW) 1, for the product is a high-newness product 0, for it is an update

Product Announcement Type Interaction variable (MULTIPLE*TIME) Interaction variable (MULTIPLE*NEW) Interaction variable (TIME*NEW) Interaction variable (MULTIPLE*TIME*NEW) Industry dummies 1) to consider the industry effect 2) 60 industries 59 dummy variables

Table 2

IV. Result A. Stock Price Response — Table2 –Provides estimates of AR for the announcement date and the surrounding days –Announcer Significant ＋ AR in days -1 to 0 Average gain ： 0.38% Consistent with previous studies –Industry rivals Small but significantly － AR in days -1 to 0 Average loss ： 0.12% The market substitution effect dominates the market expansion effect

IV. Result （ Cont. ） How much of the market value gains of innovating firms represents “ business stealing ” from rivals ？ Calculate the dollar value of gains to announcing firms and the dollar losses experienced by rival firms 1987 announcers ： 49.3m rivals ： -29.7m 1995 announcers ： 66.1m rivals ： -39.8m a substantial portion of the dollar gain to the announcers represents “ business stealing ” from the rivals

Table 3-1

Table 3-2

IV. Result （ Cont. ） Table 3 –Presents the rivals ’ two-day announcement- period average AR –39 out of 60 （ 65% ） industry have negative AR ： more significantly than expected Ho ︰ AR=0 –Rivals in technologically based industries experience the most significantly unfavorable share price response –Firms in these industries requires new innovations to stay alive –Rivals lagging behind in introducing new products in these industries are likely to lose more

IV. Result （ Cont. ） B. Cross-Sectional Analysis — Table 4 –Represents cross-sectional analysis of the announcement-period AR of industry rivals –All regression are estimated using weighted lease squares, with the weights = the inverse of the standard deviation of the market-model residuals –This procedure is used to obtain efficient estimates since the variances of the market-model residuals vary across firms

Table 4 Industry characteristics Rivals ’ characteristics Product announcement type Interaction term

IV. Result （ Cont. ） Model 1 –Includes only ACAR –Significantly － relation between rivals ’ share price effect and ACAR –The market substitution effect dominates the market expansion effect

IV. Result （ Cont. ） Model 2 –Includes ACAR, FREQ, and all variables relating to the industry characteristics – －： ACAR, FREQ, HIGH TECH, Q, RDI, DEBT RATIO –FREQ The more frequent new product announcers experience higher AR （ Kelm 1995 and Chen 2002 ） The higher AR experienced by frequent new product announcers might suggest that these firms are able to capitalize on follow – on investment projects and generate future investment opportunities => negative effect on rivals

IV. Result （ Cont. ） HI –Not significantly ＋ HIGH TECH –Significantly － –Laggards in more technologically based industries are “ punished ” more by capital market than those in less technologically based industries SIZE –Significantly ＋ –Small firms, need product innovation to survive in the market, are more vulnerable to competitors ’ challenges –Information asymmetry is more severe for small firms

IV. Result （ Cont. ） Q, RDI, DEBT RATIO –Significantly － –Firms with better investment opportunities are likely to have worthwhile investments, better investment decisions, and more growth options –Firms with high R&D intensity are expected to have greater technology capacity and opportunities for product innovation FCF, MULTIPLE, TIME –Not Significant NEW –Significantly ＋ –The market expansion effect of a new product introduction is more likely to happen when the products introduced are of high newness

IV. Result （ Cont. ） Model 3 –Include all the variables in model 2 and an interaction term — DEBT RATIO×HIGH HI –Interaction term is significantly － –DEBT RATIO is no longer significant –Leverage is less important in explaining the wealth effect of new product introductions on rivals in less concentrated industries

IV. Result （ Cont. ） Model 4 –Examine the role of four interaction terms — MULTIPLE×TIME, MULTIPLE×NEW, TIME× NEW, MULTIPLE×TIME×NEW –Chaney （ 1991 ） Firms introducing multiple products that are of high newness experience the largest wealth impact Rivals ’ share price response might influenced by the interaction effect –Interaction terms do not appear important in explaining the rivals ’ share price response –Results on the other variables are unchanged

IV. Result （ Cont. ） Model 5-8 –Repeat model 1-4 by including industry dummies –HIGH TECH and R&D are no longer significant –HIGH TECH and R&D are subsumed in the industry dummies –The results on SIZE are weaker –MULTIPLE is significant in model 6 and 7 Noisy estimates for the proxy variables

V. Conclusion The market expansion effect predicts that industry rivals should experience a positive wealth effect The market substitution effect predicts that they should experience a negative wealth effect Rival firms experience a small but significantly negative share price response The market substitution effect dominates the market expansion effect A significant portion of the wealth effect gain to the announcers represents business stealing from the industry rivals Main contribution — understanding the cross- sectional variation of rivals ’ share price response to new product announcement

V. Conclusion （ Cont. ） The wealth effects on the announcers and the industry rivals are significantly negatively related Rivals ’ share price response is more unfavorable when frequent announcers introduce new products Wealth effect on rivals varies from industry to industry Negative share price effect on industry rivals is more pronounced for smaller rival firms and for those rival firms that have better investment opportunities Rivals with higher debt level experience a more unfavorable wealth effect The wealth effect of industry rivals is significantly related to their R&D intensity Product newness is the only variable relating to product announcement type that is significantly related to rivals ’ share price response The wealth effect on rivals is more favorable when the announcing firms introduce product of high newness