Innovative efficiency and stock returns: Should we care about nonlinearity?

Recent research suggests that a firm's innovative efficiency (IE) is a strong positive predictor of future stock returns. Using a panel of 3084 international firms over the 1999-2015 period, this study attests to the predictive power of IE for subsequent returns, but disputes the linearity of the underlying relationship. Specifically, portfolio analyses and Fama and MacBeth (1973) regressions demonstrate that IE shares a robust U-shaped relationship with future stock returns, market valuations, and operating performance. This evidence is new to the literature and bears important implications for investment and security analysis, innovative-intensive firms, policy-making, and academic research as well.