Effects of Innovation Investment on Profitability and Moderating Role of Corporate Governance: Empirical Study of Indian Listed Firms

Abstract

Abstract Innovation investment decisions are always riskier business decisions, especially when it is a question of spending on research and development, but it is a vital area of decision-making which enhances growth and sustainability. First, we attempted to investigate the bidirectional causality between R&D and profitability measured in terms of NP (net profit), ROA and ROE through Granger causality test from a sample of 255 sample Indian listed firms for a period of eight years ranging from 2008 to 2015, while finding unidirectional causality only between R&D expenditure and profitability, we moved for analysing the magnitude of relationship through multiple regression model which revealed that R&D expenditure negatively affects the profitability but affects the profitability of subsequent years positively while taking lags. Further, moderating regressions equation was employed to assess the moderating role of corporate governance variables such as board size, board independence, family ownership, foreign and institutional ownership with controlling effects of size, market capital and liquidity position. The results revealed that all moderating variables except board size affect the slope of regression positively, but technically only family ownership moderates the relationship between R&D expenditure and profitability as there is significant change in f-value while moderation effect of family ownership is taken into consideration. Only board size affects negatively the relationship questioning the role of internal board and their interest in innovation for maximising personal benefits on the expense of risk-bearing shareholders and stakeholders. Our results were in conformity with some prior studies but have also shown contradiction with results of developed estates regarding role of board for balancing the agency theory conflicts, hence creating room for Indian corporate culture with a full-fledged system which can strike a balance between interest of agents and principals with protection to minority shareholders and overall stakeholders.