Back in 2006, the Chinese government began a program to encourage domestic innovation with an eye toward increasing firm value. A policy covering both independent and state-owned enterprises (SOEs) was initiated, and plans for the production of patents were put in place. Subsequently, the number of patents issued in China skyrocketed, and by 2015, it became the first country to receive more than 1 million patent applications in a single year.
The innovation initiative attracted wide-ranging attention, including the interest of Nan Jia, USC Marshall Associate Professor of Management and Organization, whose research is focused on business in China. She and her colleagues, Kenneth Huang of National University of Singapore and Cyndi Man Zhang of Singapore Management University, launched a study of Chinese SOEs that were publicly listed between 2000 and 2012. Their paper, “Public Governance, Corporate Governance, and Firm Innovation: An Examination of State-Owned Enterprises,” published in February in The Academy of Management Journal, examines how the goal of increasing innovation played out in practice. “This study,” Jia said, “is among the first to examine the balance between the quantity and the novelty of innovation in Chinese SOEs, particularly through the lens of agency risk.”
“The state’s active intent to promote innovation does indeed increase the overall number of patents produced, but it remains a tricky task for the state to ensure the balance of quantity versus quality.”—Nan Jia, Associate Professor of Management and Organization
The researchers found “implementation varied,” Jia said. “Innovation is private, proprietary and risky, which can cause state agents responding to the government’s pro-innovation plan to game the system, relying disproportionately on quantifiable outcomes (e.g., patent counts) for assessing innovation performance.
Complicating matters is the fact that state agents are not always aligned with increasing firm value – they get promoted for the number of patents they produce so they have little incentive to demand novelty.
Another factor is that governance of state agents is not always aligned with modern technology. “There’s a standard way to measure production in an industrial age economy,” Jia explained. “It’s harder to measure in a knowledge economy, where a lot of production is in the worker’s mind. It’s difficult to know as a company what can be expected.” According to the paper, some state agents prioritize the quantity of innovation because it is more-readily captured by objective metrics. But studies have shown that it’s the quality of innovation that contributes to a firm’s innovative capability, competitive advantages and long-term survival. “Overlooking the novelty of innovation undermines added value,” said Jia.
In their study, the team examined how governance can address the imbalance of quantity and quality of innovation. They measured the impact of conventional corporate governance tools, including monitoring, and aligning agents’ incentives with firm value, and saw that these tools can improve the output of novel innovation.
But they also found substantial variation in corporate governance across regions in China, leading to inconsistencies in the degree to which SOE agents were incentivized. So, the researchers looked beyond corporate governance of agents (the predominant focus in prior studies), to the accountability of the principal of the SOE. They found principals can also effectively shape the innovation outcomes of a firm.
“A core feature of the political system in China is the variability of quality public governance,” Jia said. “When it’s better, state principals of SOEs function more conscientiously, reducing risk and improving firm innovation. Moreover, we found the effect is even more notable when higher-quality public governance is coupled with good corporate governance.”
Jia’s team is the first to go beyond the conventional perspective that firms choose to develop more- or less-novel technologies. They demonstrate that agency risk and improper use of governance diminishes innovation. According to their research, governance is most effective when both corporate and higher-quality public governance work in tandem.
“The state’s active intent to promote innovation does indeed increase the overall number of patents produced,” Jia said, “but it remains a tricky task for the state to ensure the balance of quantity versus quality.”