Document Sample

                                     VIOLINA RINDOVA
                                Robert H. Smith School of Business
                                     University of Maryland
                                       Van Munching Hall
                                    College Park, MD 20742

                                   FRANK T. ROTHAERMEL
                                      College of Management
                                  Georgia Institute of Technology
                                      Atlanta, Georgia 30308

                                         DAX BASDEO
                                Robert H. Smith School of Business
                                     University of Maryland
                                       Van Munching Hall
                                    College Park, MD 20742

                                           Working Paper

                                           August 22, 2005

                                 Submitted for possible inclusion in

                     SMS Pre-conference Junior Faculty Research Workshop

                           Entrepreneurship and Strategy Interest Group

The first two authors contributed equally to this paper, and are listed alphabetically. We thank Suresh
Kotha and Ken Smith for helpful discussions, comments, and suggestions, and Megan Menkveld, Steven
Hinman, and Shanti Dewi Anak Agung Istri for research assistance.


       While an important question to investors and scholars alike, we know little about how the

value of new ventures in emerging industries is determined. We address this question by

developing an integrative theoretical framework in which we combine more traditional
evaluation models with an emerging sensemaking perspective of firm valuation. Taken together,

we suggest that the market value of new ventures in a nascent industry is determined in part by a

managerial enactment process. In particular, we emphasize the social construction of market

processes, and suggest that managers proactively shape investors‟ expectations concerning their

value-creating strategies, enacted through new product announcements and “substantiated”

through investments in intangible assets, partnering relationships, and managerial accounts of

unobservable sources of competitive advantage. We test our theoretical model on a longitudinal

panel of Internet start-ups, where we leverage fine-grained and theoretically proximal data. We

find broad support for the hypothesis that market value is enacted by deliberate strategic choices

of smart managers.

Key words: new ventures, signaling, sensemaking, valuation, Internet

Running Header: Enacting Market Value
                                                                                 Enacting Market Value


     Determining the value of new firms in emerging industries is “a vexing problem for

investors” (Sanders and Boivie, 2004: 168). Numerous factors contribute to investors‟

difficulties with evaluating the value-creating potential of new firms in emerging industries.

First, while conventional financial valuation models require information about the expected cash

flows from the activities of a firm, new firms lack operating histories that provide such

information. For example, Erickson and Jacobson (1992) show that in established industries a

firm‟s profitability is the key determinant of investor valuations. New firms, however, often

operate at a loss for some length of time. In emerging industries, the problems with seizing up

the performance potential of firms are exacerbated by the fact that new firms often introduce

unproven business models in their attempt to create value for investors (Amit and Zott, 2000).

Further, in such industries investors and analysts lack both codified knowledge through which to

evaluate the new business models of these firms, as well as industry-specific experience, on

which they can draw to make inferences (Sanders and Boivie, 2004: 167).

     In other words, emerging industries are contexts characterized not only by uncertainty about

the ability of firms to perform, but also by a lack of knowledge about the cause-effect

relationships that specify how firms create value.1 According to Schackle (1972: 76) in such

environments “orderly society suddenly disintegrates and cascades into a series of new patterns”
(cited in Mosakowski, 1997: 422). Indeed, the need to deal with changes in patterns of meanings

has been posited as a key challenge facing entrepreneurs entering emerging industries (Aldrich

and Fiol, 1994). Thus, while researchers recognize that emerging industries pose a significant

problem with valuing the new firms competing in them, little research has been directed toward

understanding how the strategies of new firms in such contexts may influence investor

interpretations and valuations. Yet, understanding how investors value such new firms in

emerging industries is a question of considerable theoretical and pragmatic importance because

 Mosakowski (1997) argues that the causal ambiguity in new and emerging markets significantly exceeds the causal
ambiguity in established industries and is relatively rare.

                                                                          Enacting Market Value

such contexts often provide the most fertile opportunities for wealth creation (Amit and Zott,


    Recently, researchers have recognized the need to develop substantive theoretical

understandings about how investors make sense and evaluate new firms in emerging industries.

Sanders and Boivie (2004: 168), for example, argue that in emerging markets investors “are

likely to shift emphasis from objective financial and operating data, which is lacking or not well

understood, to indirect, secondary information sources that are better understood.” They

empirically investigate the effect of observable governance attributes on investors‟ valuations of

Internet firms and find that stock-based managerial incentives and institutional and large-block

stock ownership are positively related to the market values of these firms. Their findings

therefore provide evidence that investors use the strategic attributes of new firms as information

inputs in making inferences about their value-creating potential. Zuckerman and Rao (2004)

analyze the co-movement of Internet stocks during 1996-2000 in an effort to understand how

investors valued these stocks. They observe relatively low levels of co-movement among

Internet stocks, which they interpret to mean that rather than being highly optimistic about the

Internet category as a whole, investors distinguished among different types of Internet firms and

valued them accordingly.

    Both of these recent efforts to understand the valuation logics that investors apply under
conditions of extreme ambiguity – which characterized the Internet between 1995 and 2001 –

provide evidence that investors look at the strategic characteristics of firms and “sort them out”

in ways that result in differential valuations of these firms. Yet, these studies also suggest that

traditional financial models relying on economic performance alone have limited applicability in

such contexts, and that further theoretical and empirical work is needed in order to understand

the “theories of value” investors apply in such contexts (Zuckerman and Rao, 2004).

    In this paper we address this need by developing a framework that analyzes the construction

of market value of new firms as an enactment process. We draw on theoretical and empirical
work that recognizes that market processes are socially constructed (Abolafia and Kilduff, 1988;

                                                                        Enacting Market Value

Aldrich and Fiol, 1994; Rao, 1994; Miner and Haunschild, 1997; Rindova and Fombrun, 1999;

Lounsbury and Glynn, 2001) to argue that new firms proactively shape investors‟ expectations of

their value-creating potential by making claims to value creation through their new product

announcements, and “substantiating” these claims through their investments in intangible assets,

partnering relationships, and managerial accounts of their unobservable sources of competitive

advantage. In our view, in environments characterized by extremely high levels of ambiguity,

firms attract investors‟ attention through new product announcements, which constitute claims

that a new firm has and/or is developing capabilities to deploy the new technologies around

which the industry has emerged into marketable products and services. While these “claims to

value” as we call them by themselves may be what economists call “cheap talk” (Farrel and

Gibbons, 1989), firms can “support” these claims by making strategic choices that are consistent

with these claims. Therefore, we argue that under conditions of high ambiguity firms can enact

their market value through a complex combination of market actions, investments in resources

and relationships, and strategic projections, all of which combine to generate positive investor

expectations about their value-creating potential.

    To enact market value in such environments firms need to both make claims to value by

announcing new products and to back up these claims through strategic choices and behaviors

that lend credibility to the claims. In doing so, new firms differentiate themselves from
competitors, and proactively lead stakeholders to view them as having high potential to create

value for them. While all firms benefit from favorable stakeholder perceptions, such perceptions

are critically important under conditions of high uncertainty, because such conditions lead to

price discounting (Riley, 1989). As a result, new firms are likely to be undervalued, unless

investors perceive them as having high value-creating potential. Zuckerman (1999), for example,

finds evidence that lower legitimacy is associated with lower market values – a phenomenon he

terms “illegitimacy discount.” In contrast, we propose that firms that make claim to value and

substantiate their claims can enact a “credibility premium.”

                                                                        Enacting Market Value

    Our theoretical framework of how new firms can enact their value through their strategic

choices extends extant research on the legitimation of new firms through third party

endorsements, which reduce stakeholder uncertainty about new firms (Rao, 1994; Stuart, Hoang,

and Hybels, 1999; Pollock and Rindova, 2003). While we acknowledge that affiliations with

prominent others may be important to gaining stakeholder attention and confidence, relationships

are only one aspect of the strategic choices of firms that need to be taken into account in

considering how new firms proactively construct their market value. Our framework provides a

more integrative view, which recognizes the informational value of a wide range of strategic

choices under conditions of ambiguity. This is because, as we discuss later, ambiguity reduces

the ability of decision makers to decide a priori what the relevant factors are (Mosakowski,

1997). As a result, different combinations of strategic choices may enable new firms to construct

their value, and we submit that these possibilities need to be considered more broadly.

    Our perspective also contributes to and extends research that highlights the signaling value

of the strategic choices of firms (Zajac and Westphal, 2004). In recognizing the information

value of the strategic choices of firms, our perspective shares some commonalities with signaling

theory, which has suggested that the strategic actions of firms enable observers to form

expectations about their unobservable attributes and future behaviors (Weigelt and Camerer,

1988). Signaling researchers, however, focus on actions that can serve as “credible” signals,
because they are costly and/or irreversible (Heil and Robertson, 1991). In contrast, we argue that

a wide range of strategic behaviors – including costless and nonverifiable claims, such as new

product announcements (Farrel and Gibbons, 1989) – provide investors with information about a

firm‟s strategy. In our view, under conditions of ambiguity, the internal consistency, determined

by the simultaneous presence or absence of certain strategic choices – that enables investors to

“verify,” or at least give credence to actions that otherwise would be considered “cheap talk” –

and rewards the firm with superior valuation. In this “sensemaking” perspective for

understanding how investors value firms in emerging industries we theorize how the strategic
choices of new firms combine to reduce stakeholder uncertainty about the value-creating

                                                                        Enacting Market Value

potential of a firm and to increase their willingness to exchange resources with the firm, which

has significant implications for performance and survival (Stuart, Hoang, and Hybels, 1999).

    We test our ideas empirically on a sample of new firms that entered the Internet domain

during the years of its emergence (1995-1998). We tracked the firms‟ strategic choices and

valuations annually over the four year period between 1998 and 2001, thus covering both boom

(1998-1999) and bust years (2000-2001) for Internet stocks. In addition, we took great care in

tracking the strategic choices of Internet firms in a fine-grained manner to test our model of

enacting market value. Several recent studies have used the Internet context to study how

investors value firms under conditions of ambiguity, because the extreme levels of ambiguity

associated with the Internet generated valuation anomalies that called into question extant

theories of firm valuation (Cooper, Dimitrov, and Rau, 2001).

    The ideas we develop in the paper, however, extend beyond investor valuations of new firms

and provide a more general understanding of the issue of how new firms competing in highly

ambiguous environments may enact their value with various stakeholders. We focus on investor

valuations because as Zuckerman and Rao (2004: 208) observe: “whereas patterns of valuation

or interpretation are invisible and only periodically observable in most domains, capital markets

require the continuous enactment of interpretative schemes through reaction to new

information.” Financial markets also provide an opportunity to examine rather specifically how
the enactment process leads firms‟ values to depart from a baseline that can be established on the

basis of their financial performance assets.


Valuation as Sensemaking

    Emerging industries are environments characterized by extremely high levels of ambiguity.

Ambiguity in general is defined as “an intermediate state between ignorance (no distributions are

ruled out) and risk (all but one are ruled out)” (Einhorn and Hogarth, 1986: S229). Thus,

ambiguity varies in degrees (Mosakowski, 1997). Very high levels of ambiguity may be closer to
a state of ignorance, in that decision makers lack not only information on the basis of which they

                                                                          Enacting Market Value

can draw inferences about expected distributions of outcomes, but also lack clear cause-effect

frameworks that can guide their inferences reliably. Under such conditions investors‟ efforts to

evaluate new firms may be better understood as a constructive sensemaking process, in which

diverse and complex cues are integrated in forming perceptions about the an actor. This is

because under conditions of high ambiguity pre-existing knowledge structures have limited

applicability for interpreting the situation (Rokeach-Ball, 1975 Mosakowski, 1997). As a result,

investors cannot know what the critical strategic factors in this industry may be (Amit and

Schoemaker, 1994) and instead are likely to rely on a variety of information cues to identify

firms whose strategies provide more “consistent evidence” that they have the potential to create

value in this novel, ambiguity-ridden environment. In other words, rather than focusing on

specific actions and behaviors that can be deemed as relevant a priori, investors may look at a

variety of actions and choices of firms to form overall opinions about their value-creating

potential of a firm.

    The valuation of new firms in emerging industries therefore may involve socio-cognitive

processes similar to those involved in the formation of expectational assets, such as reputation

(Clark and Montgomery, 1998). From a socio-cognitive point of view, such opinions reflect

dispositional inferences drawn on the basis of observed consistency in behaviors (Fiske and

Taylor, 1991). As a result, a distinctive feature of the interpretative processes through which
investors form opinions about the value-creating potential of new firms in emerging industries

may be that investors are likely to attend to a wide variety of strategic behaviors, looking for a

pattern across these different types of behaviors that is indicative of internal consistency and

strategic coherence (Teece, Rumelt, Dosi, Winter, 1994).

    Additionally, a necessary but not a sufficient step in this process is that investors focus their

attention on a particular firm. In social cognition terms, the formation of investors‟ opinions

about a firm‟s value crating potential is likely to be affected by its salience defined as extent to

which the firm “stands out” relative to its competitors. Salience increases the attention allocated
to a firm (Fiske and Taylor, 1991), making it possible for investors to attend to the diverse cues

                                                                         Enacting Market Value

that become inputs in their opinion formation process. To summarize, we argue that under

conditions of high ambiguity investors are likely to value more highly firms whose behaviors

attract their attention and whose choices and actions enable investors to “read” a consistent

message about the value-creating potential of the firm.

    Based on these ideas we develop a model of how firms enact their market value by attracting

investors‟ attention through “claims to value” and by demonstrating internal consistency across

their various strategic choices in ways that substantiate these claims. Figure 1 depicts our model

of enactment of market value by new firms in emerging industries. The model represents new

product announcements as claims to value, which have a positive effect on investors‟ valuations

of a new firm only to the extent that they occur in combination with other strategic choices that

substantiate them, including investments in intangible assets, strategic partnerships, and

managerial accounts about the sources of competitive advantage of the firm. This “substantiation

logic” is represented in the absence of a direct relationship between new product announcements

and market value, as a series of positive interactions between new product announcements and

investments in upstream and downstream intangible assets, relationships, and managerial

accounts. The interactive relationships we propose between these strategic choices and new

product announcements also suggest that the role that these strategic choices play in influencing

investor perceptions of firm value is enhanced by the claims to value creation that new product
announcements make.
                                    Insert Figure 1 about here
Claiming Value: Attracting Attention through Innovative Actions

    Given that new industries usually emerge around new technologies, taking actions that

communicate to investors a firm‟s efforts to utilize the technology and create new products and

services are central to attracting investor attention and making a firm stand out relative to

competitors. Thus, our model recognizes specifically how firms‟ efforts to signal their innovation

strategies affects investors‟ perceptions of their value. The innovation strategies of firms are
likely to be of importance to investors because new industries emerge around new technologies,

                                                                         Enacting Market Value

which create opportunities for novel forms of value creation (Schumpeter, 1934). Innovation

researchers, for example, emphasize that technological innovations generates significant amount

of uncertainty both about “the mix of services a given set of technologies will deliver” and the

consumer demand for them (Abernathy, Clark and Kantrow, 1983: 25), and about the

competencies firms need to develop in order to supply these the ultimately desirable attributes

(Abernathy and Clark, 1985; Benner and Tushman, 2003). Because the uncertainty surrounding

the new technology is one of the most important sources of ambiguity in the emerging industry,

new product introductions, or even announcements that such actions will be taken (Zajac and

Westphal, 1998) are likely to attract significant investor attention. This is because new product

announcements supply information about the market applications (and therefore fit with

consumer preferences) that different firms are discovering for the new technologies defining the

industry (Levinthal and Adner, 2002). Therefore, investors are likely to pay attention to new

product announcements because they enable them to learn about how firms in the industry seek

to create customer value and to attract customers (Rindova and Fombrun, 1999).

    In addition, new product announcements may provide investors with some – albeit weak –

indications about a particular firm‟s underlying capabilities to utilize the technology in

productive and potentially value-creating ways (Moran and Ghoshal, 1999). To the degree that

the more novel a technology, the more difficult it is for a firm to learn how to exploit it (Winter,
1997), new firms are likely to differ significantly in the frequency with which they announce

new products, enabling investors to differentiate among them. To the degree that new product

announcements are unevenly distributed among competing firms, those making product

announcements more frequently are likely to gain salience in the minds of investors. As a result,

new product announcements can be viewed as visible “claims to value,” in that they provide the

market with information about the new firm‟s capabilities to create novel forms of customer

value through new products and services. Overall, as claims to value, new product

announcements serve to attract investor attention and present the firm as a candidate for being
considered as having high value-creating potential. In that sense, they may be a necessary, but

                                                                          Enacting Market Value

not a sufficient condition for investors to form positive opinions about the value-creating

potential of a firm, which in turn affect the prices they are willing to pay for a firm‟s stock.

Substantiating Claims: Strategic Choices as Supporting Evidence

    Intangible Assets. In order to develop more substantive expectations about the value-

creating potential of a firm, investors may need to validate the value creation claims made

through product announcements against the backdrop of other strategic choices of the firm. Once

new product announcements have attracted the attention and piqued the interest of investors

toward a given firm, investors may seek to elaborate their impressions of the firm by seeking to

assess the unobservable “quality” or strengths of the firm‟s innovation strategy. In other words,

in seeking to form impressions of the firm, investors are likely to look for additional “evidence”

that the firm is making choices that support the innovation strategy signaled through new product

announcements, and thus increasing the likelihood that the firm will be able to create value. A

firm‟s upstream investments in R&D are likely to be informative to investors because they are

considered investments that add to a firm‟s stock of knowledge (Hall, Griliches, and Hausman,

1986), and numerous studies have demonstrated a positive relationship between a firm‟s

investments in R&D and its innovative input, often measured as patents (e.g., Ahuja, 2000; Hall

and Ziedonis, 2001; Ziedonis, 2004). For example, investors may use information about a firm‟s

investment in upstream intangible assets as a validation that the firm is developing the
underlying capabilities that generate “quality” product innovations, rather than a slew of “empty”

product announcements. This phenomenon is well established in the software industry, for

example, where it is common to announce “vapor ware,” these are announcements of software

products firms claim that exist, but yet have to be (fully) developed. Because R&D investments

are costly, they can also serve as a direct signal revealing “true quality” of underlying innovative

capability, because firms will not make them unless they expect that they can reap benefits from

such investments. For example, Apple‟s resurgence can be partly explained by its sustained high

R&D expenditures during the last decade, which averaged 7.2% for the period between 1990 and
2000, compared with merely 1.6% for Dell (COMPUSTAT). These arguments suggest that a

                                                                          Enacting Market Value

firm‟s investments in upstream intangible assets can serve to substantiate a firm‟s claims to

value, and thus we hypothesize that:

    Hypothesis 1a: When combined with upstream investments, a firm’s new product
    announcements have a positive effect on investors’ valuations of the firm.

    The value created through innovations contributes to a firm‟s profitability only if value is

realized in exchanges (Moran and Ghoshal, 1999). Therefore, a firm‟s downstream investments

in marketing serve to reassure investors that the firm is securing access to customers. Similar to

upstream investments, downstream investments are costly, and are more likely to be incurred by
firms that believe that their innovative activities are creating value for customers, which will be

realized in exchanges. Therefore, downstream investments provide investors with additional

signals revealing the “true quality” of the underlying innovative capability of a firm. These

arguments suggest that a firm‟s investments in downstream intangible assets also serve to

substantiate a firm‟s claims to value. Therefore, we hypothesize that:

   Hypothesis 1b: When combined with downstream investments, a firm’s new product
   announcements have a positive effect on investors’ valuations of the firm.

    Partnering Relationships. The extent to which a firm has developed relationships with

partners also provide investors with valuable information about additional resources that a firm is

gaining through its network of relationships, including network resource of timing, access, and

referral (Gulati, 1999). Partnerships may also indicate that a firm is in a position to accelerate its
learning by gaining access to the proprietary capabilities and processes of its partners (Khanna,

Gulati, and Nohria, 1998). This additional access to resources and learning opportunities is likely

to increase investors‟ confidence regarding the innovative capabilities of the firm and to

substantiate its claims to value. In addition, researchers have pointed out that partnering

affiliations are highly informative to stakeholders because the parties involved in the

partnerships, such as other firms in the emerging industry or related sectors are likely to be more

knowledgeable about resources and capabilities of the focal firm. As result, their choice to
partner with the focal firm serves as signal of its underlying quality (Benjamin and Podolny,

                                                                         Enacting Market Value

1999). For example, Stuart et al. (1999) documented reputation spillovers from established actors

to new ventures, because new ventures that had ties to reputable partners where faster to go to

initial public offering (IPO), and obtained higher IPO valuations. Together these arguments

suggest that partnering relationships also serve to substantiate a firm‟s claims to value, leading us

to hypothesize that:

   Hypothesis 2: When combined with strategic partnerships, a firm’s new product
   announcements have a positive effect on investors’ valuations of the firm.

    Managerial Accounts. So far we argued that firms make claims to value through new
product announcements, which attract investor attention and interest, but have actual effects on

investors‟ valuations of a new firm only when the strategic choices of new firms in terms of

investing in intangibles and developing strategic partnerships substantiate them. While such

observable choices of the firm can provide investors with additional information about a firm‟s

strategies and their implications for its value-creating potential, most of the intangible resources

and capabilities that new firms develop remain hidden for observers, such as investors (Jacobson,

1992). When measured directly, such unobservable intangible assets as organizational culture

(Barney, 1986; Hansen and Wernerfelt, 1989) and market orientation (Narver and Slater, 1990)

have been found to explain significant proportion of the variance in inter-firm differences in

performance (Jacobson, 1992). Therefore, information about the accumulation of unobservable

intangible assets by a new firm, such as development of organizational culture, achievement of
high level of customer satisfaction or employee morale, can also serve to substantiate the claims

to value creation made by the firm.

    A firm can provide such information in various communications to stakeholders. Self-

reported information, however, is expected to be “read” with skepticism by other market actors,

because of the incentives of the firm to provide biased, self-serving accounts regarding its

sources of competitive advantage. Yet, to the degree that such accounts make new information

available about a firm, they have the potential to influence the formation of investors‟ opinions
about the firm. Further, when such information is provided in legally mandated financial

                                                                         Enacting Market Value

reporting documents, for example, the institutional monitoring over such documents may

mitigate investor skepticism about the accounts provided in them to some extent (Cambell and

Krakow, 1980).

    Finally, in environments characterized by high levels of ambiguity, managerial accounts

may not only provide information about otherwise unobservable sources of competitive

advantage for a firm, but they may also clarify to investors the strategic logics employed by the

firm‟s management and may help investors learn about the industry and how firms seek to create

value in it. Recall that given the novelty of the technology and the ambiguity surrounding the

industry, investors have limited or no codified knowledge and industry experience of their own

to rely on (Sanders and Boivie, 2004). In other words, managerial accounts about the

unobservable sources of competitive advantage a firm has developed or is in the process of

developing, may help investors understand the firm better and have greater confidence in its

value-creating potential. Based on these arguments, we hypothesize that:

    Hypothesis 3: When combined with managerial accounts of its unobservable sources of
    competitive advantage, a firm’s new product announcements have a positive effect on
    investors’ valuations of the firm.


Data and Sample

    We compiled a list of 101 publicly traded pure Internet firms based on the following

sources: (1) the list of top-50 Internet firms in 1998 and 1999 published by Internet World; and

(2) the list of public Internet firms published in the September 1999 issue of Business 2.0. From

this initial list we excluded one non-U.S. firm, nine firms for which we lacked data on some of

the independent variables, and five firms that were not public as of June 30, 1999. Thus, our

sample was based on 86 publicly-traded U.S. Internet companies, for which we tracked their

strategic choices and market valuations annually between 1998 and 2001. Given the four year

study period, this resulted in 213 firm-year observations after accounting for the fact that not all

                                                                         Enacting Market Value

firms were in operation over the entire period and the presence of missing data. The majority of

the firms operated in the business-to-consumer segment (B2C).

    We obtained the financial data from the COMPUSTAT database, supplemented by firms‟

SEC 10-K and 10-Q reports. We collected all other data by manually coding publicly available

information on the Internet and databases like Lexis/Nexis. Given the novelty of the Internet and

the lack of performance histories of Internet firms, our choice of better-established firms enabled

us to collect more reliable financial and other data.

Dependent Variable

    Building on Lindenberg and Ross‟s (1981) pioneering study, Tobin‟s q has been extensively

used in many empirical studies as an improvement over accounting returns when proxying for

the market value of a firm. Further, as the ratio of the market value of a firm to the replacement

cost of its tangible assets, values of Tobin‟s q greater than 1 are an indication of the presence of

intangible factors from which a firm earns rents (Simon and Sullivan 1993; Wernerfelt and

Montgomery 1988). Tobin‟s q can therefore be seen as providing an indication of a firm‟s

ability to sustain its competitive advantage, by capturing the value of a firm‟s competences or

intangible assets and the isolating mechanisms through which these rents are appropriated and

protected (Teece et al., 1994; Peteraf, 1993; Rumelt, 1984). We calculated Tobin‟s q following

the method specified by Chung and Pruitt (1994), as this method does not require out-of-
COMPUSTAT data, but explains at least 96.6% of the variability of Tobin‟s q as calculated using

the method specified by Lindenberg and Ross (1981). Tobin‟s q was calculated using the

following formula:

       Tobin’s q = (Market Value + Preferred Stock Liquidating Value + Current Liabilities

                       – Current Assets + Book Value of Inventories + Long Term Debt) / Total


Independent Variable

    New Product Announcements. Consistent with other empirical studies examining firm
actions, our measure of new product announcements was derived from the coding of Lexis-Nexis

                                                                          Enacting Market Value

reports (Ferrier et al. 1999; Miller and Chen 1994; Smith et al. 1991; Young et al. 1996).

Keywords were developed and used in combination with the firm names and sample years to

search the Lexis-Nexis database to identify articles containing possible firm new product activity.

Based on coding of Lexis/Nexis headlines containing each firm name and innovation related

keywords (e.g. innovation, new product), a variable indicating the number of new product

announcements per firm by year was constructed.

Moderating Variables

    Upstream Investments and Downstream Investments. The positive relationships between

advertising and research and development expenditure and a firm‟s market value is supported by

a wealth of theoretical and empirical work (e.g., Montgomery and Wernerfelt, 1988; Cockburn

and Griliches, 1988; Amit and Wernerfelt, 1990; Megna and Klock, 1993, Simon and Sullivan,

1993; Wu and Bjornson, 1996). Downstream Investments are measured using firms‟ SG&A

expenditures in each year. This expenditure results in information being provided to

stakeholders on the value-creating activity of a firm and the utilization of a firm‟s intangible

assets. Upstream Investments are measured using firm R&D expenditures in each year. Such

expenditure indicates that a firm is adding to its stock of knowledge thus leading to a higher

market valuation (Hall, Jaffe and Trajtenberg 2005).

    Strategic Partnerships. This variable was derived from the number of partnering agreements
per firm by year, based on coding of Lexis/Nexis headlines containing the firm name and

partnering related keywords. In calculating the number of strategic partnerships for each firm,

actions such acquisitions or product sales/contracts were not included.

    Managerial Accounts. This construct is consistent with Jacobson‟s (1992) discussion of

unobservables. Because these assets are not only not observable, but it may be difficult to even

develop observable proxies for them, e.g. employee morale, or esprit de corps, or

“entrepreneurial culture,” their effect on the performance of firms may be a function of the

degree to which the management of a firm proactively communicates them to investors and
emphasizes their value to the firm from the managements‟ point of view. Therefore, we

                                                                         Enacting Market Value

operationalized this construct as the degree to which the top management of a firm refers to

various intangibles in the firm‟s formal communications with investors. So, perhaps there are

“observable” and “unobservable” intangible assets – at least from investor point of view, and

given standard information that is being reported.

    While other studies of intangible assets have focused on proxies such as R&D and

marketing expenditures, we have developed a unique approach to measuring firm managements‟

views on the key intangibles of their firms. Using the EDGAR database, we searched annually

the 10-K reports, including 10-K405, 10-K/A, and 10-KSB‟s for each of the firms in our sample.

From these reports, we developed specific keywords and decision rules, and subsequently coded

them based on the content of the report. We employed two independent coders at two different

institutions, and found the inter-coder reliability to be satisfactory. Seven categories of

intangibles emerged from our analysis. We dummy-coded them as follows:

       Customer Base – a “1” was coded when specific mention was made of any quantifiable

       number or a sample list of actual customers. This provided a specific indication of

       revenue sources for a firm and thus an indication of an established customer base. Firms

       that reported only a general list of customer types with no definitive indication of a

       revenue source were not considered as having an established customer base.

       Internet Traffic – a “1” was coded when mention was made of internet traffic to a firm‟s

       Sales Force – a “1” was coded for firms that indicated that they had an in-house sales

       force or the ownership of a specific sales office.

       Employees – a “1” was coded for companies that indicated a reliance on specialized or

       skilled employees.

       Operational Technology – a “1” was coded in instances were a firm indicated that they

       owned and utilized operational technology (such as a network or some other form of

       physical infrastructure) in their business.

                                                                        Enacting Market Value

       Strategic Partnership – a “1” was coded to reflect if a firm had any strategic partnerships

       in place.

       Brand Recognition – a “1” was coded were firms made an indication of the presence of

       an established brand for their business. This included mention of a firm‟s efforts to

       increase or expand awareness as it implies some existing brand recognition.

    The managerial accounts construct was then calculated as the sum of these seven dummy

variables. This variable therefore provides a measure of unobservable intangible assets that may

contribute to the competitive advantage of a firm, with higher values indicating potentially

greater sources of competitive advantage for a firm.

Control Variables

    Several controls for other factors that can have an impact on a firm‟s valuation were utilized.

We controlled for firm age, calculated as the number of years since a firm‟s initial public

offering; firm size was calculated as the natural logarithm of firm sales (to enhance the normality

distribution of this variable) in a given year; and cash (as measured by the short-term cash

reserves and cash equivalents held by a firm) was used as a measure of the tangible assets of a

firm. Finally, given the phenomenal valuation of Internet-related companies prior to 2000, a

dummy variable was coded to indicate boom and bust periods, with the years 1998-1999 coded

as „1‟, and 2000-2001 coded as „0‟.
    To enhance the interpretability of the results and to reduce potential collinearity, we

standardized the independent variables prior to generating the interaction terms (Cohen, Cohen,

Aiken, and West, 2003). Standardization improves the robustness of the analysis without

degrading the quality of the data. Moreover, we tested for the predicted moderation effects

through the inclusion of the direct and interaction effects. This is a conservative approach of

examining moderation effects, because the interaction terms are tested for significance after the

direct effects are controlled for. Table 1 provides both descriptive statistics and Pearson

correlation coefficients.
                                      Insert Table 1 about here

                                                                       Enacting Market Value

    The data used in this study are longitudinal, and thus represent a panel dataset. Panel data

follow a given set of companies over time, and thus provide multiple observations on each firm.

It is important to note that a majority of empirical work in strategic management relies on cross-

sectional data, and does therefore not allow for causal inferences (Hitt, Gimeno, and Hoskisson,

1998). Panel data are considered a superior alternative due to distinct advantages over cross-

sectional data (Hsiao, 2003). Panel data also enable the researcher to draw on a larger sample,

and thereby increase statistical power and reduce the threat of multicollinearity among

independent variables, which in turn enhance the efficiency of the econometric estimates (Boyd,

Gove, and Hitt, 2005).

    We used generalized least square (GLS) regression analysis to test the hypotheses advanced

(Greene, 2003). The GLS procedure produces more efficient estimates than a general linear

regression model, because it minimizes a weighted sum of squared residuals. GLS estimates are

corrected for autocorrelation and cross-section heteroscedasticity, while estimating weighted

averages of the within and between firm effects. We applied a more conservative approach by

estimating the GLS regression models with White heteroscedasticity-consistent standard errors

and covariances. This estimation procedure produces covariances that are robust to general

heteroscedasticity, because variances within a cross-section are allowed to differ across time.

    An important advantage of utilizing panel data is the ability to control for unobserved
heterogeneity in the firms in our sample. Idiosyncratic firm characteristics can lead to biased and

inconsistent estimates under ordinary least squares regression as a consequence of omitted

variables (Greene, 2003). To account for this, we applied a fixed effects approach incorporating

one dummy variable for each firm in the sample to capture unobserved heterogeneity (e.g.,

Bowen and Wiersema 1999; Hamilton and Nickerson, 2003). The results of our analysis are

shown in Table 2.
                                    Insert Table 2 about here

                                                                        Enacting Market Value


    Table 2 shows the results of our analysis predicting the effects of a firm‟s new product

announcements and its interactions with other signals on investors‟ valuation of the firm.

Hypothesis 1a argues that a firm‟s new product announcements will have a positive effect on

investors‟ valuations of the firm when combined with a firm‟s upstream investments. Model 3

demonstrates support for Hypothesis 1a at the p < 0.05 level. Hypothesis 1b argues that a firm‟s

new product announcements will have a positive effect on investors‟ valuations of the firm when

combined with a firm‟s downstream investments. Model 3 shows a significant interaction at the

p < 0.001 level, however the negative coefficient suggests a negative effect on investors‟

valuations of the firm.

    Hypothesis 2 argues that a firm‟s new product announcements will have a positive effect on

investors‟ valuations of the firm when combined with a firm‟s strategic partnerships. Model 3

demonstrates support for Hypothesis 2 at the p < 0.001 level. Hypothesis 3 argues that a firm‟s

new product announcements will have a positive effect on investors‟ valuations of the firm when

combined with a firm‟s managerial accounts of its unobservable sources of competitive

advantage. Model 3 demonstrates support for Hypothesis 3 at the p < 0.001 level.

    Overall, our analysis shows strong support for the positive impact of a firm‟s new product

announcement on its valuation given that these announcements are made in conjunction with
other types of signals – most notably, its investment in research and development, its accounts of

unobservable sources of competitive advantage, and its strategic partnering actions.


    We combine economic and interpretative theoretical lenses to shed light on the question of

how investors value new firms competing in contexts characterized by extreme ambiguity, such

as emerging industries. We integrate ideas from the resource-based theory of the firm (Barney,

1991) and the Austrian school of economics (see Jacobson, 1992 for a review) to theorize about

firms‟ strategic choices that provide investors with relevant information about the abilities of
firms to create value for them. For example, incorporating both the perspective of the Austrian

                                                                         Enacting Market Value

school of economics, which emphasizes market actions as key driver of firm performance

(Jacobson, 1992; Young et al., 1996) and from the resource-based, which emphasizes the

importance of resources, and in particular, of intangible assets, we develop and test hypotheses

about the effects of both market actions and the accumulation of intangibles on investors‟

perceptions of a new firm‟s value-creating potential. Importantly, we embed both of these logics

within a model that recognizes that under conditions of extreme ambiguity investors‟ evaluations

of firms reflect a socio-cognitive processes of opinion formation, whereby investors actively

attend to diverse information cues and look for consistency in them (Fiske and Taylor, 1991) to

form inferences about firms. Thus, our findings are consistent with the ideas in RBV and

Austrian economics about the value of both actions and resources in evaluating a firm‟s strategy.

Yet, the socio-cognitive perspective we advance highlights that the value of new firms is best

enacted when actions and resources are combined with strategic efforts to influence

stakeholders‟ opinions about the firm (Rindova and Fombrun, 1999). Future research should also

seek to understand if and how, as an industry evolves from emergence to growth and maturity,

the relative importance of actions, resources, and strategic communications for influencing

investor valuations may change.

    Our model is consistent with the basic idea in finance that investors use “all available

information” to evaluate firms. A contribution of our study is that it brings to the forefront the
process of using “all available information.” Our findings are consistent with the idea that

because firm newness and industry ambiguity may make many standard summary metrics of

firm performance unavailable or unreliable, investors engage in direct assessments of the

strategic choices of firms and their implications for the value-creating potential of the firm. In

our view, by making “claims to value” through new product announcements firms may “assist”

investors in forming such assessments. Although competing firms have incentives to bias this

process in their favor, the evidence we find about how investors use a variety of a firm‟s strategic

choices as confirmatory evidence leads us to agree with Lee‟s (2001: 82) conclusion that even
under conditions of high ambiguity, “the market is not easily fooled.”

                                                                         Enacting Market Value

    Our study makes an important contribution to research in strategy and entrepreneurship by

being one of the first to examine the effects of diverse aspects of a new firm‟s strategy on its

market value. First, we observe, as we predict that new product announcements have no direct

effect on the market value of new firms; however, they play an important role as claims to value

and interact positively with the investments of a firm‟s investments in upstream intangible assets,

with its partnering efforts, and with its self-reported accumulation of intangible assets in general.

These findings suggest that rather than precariously standing between being viewed as

substantive (Lee, Smith, and Grimm, 2003) and symbolic (Zajac and Westphal, 1998) actions,

new product announcements play an important role which can be understood in terms of making

claims to value creation. While these claims may serve different communication purposes with

different audiences, such informing customers about new forms of product value available or

soon to be available, undermining the claims of competitors, or attracting investor attention, such

actions perform important information functions across audiences. To disregard them as “cheap

talk” creates the risk of overlooking important processes through which market value is enacted.

Future research should seek to understand the conditions under which “cheap talk” has

substantive effects on market dynamics, as for example in the case of substantiating such talk

with other investments.

    Second, our results are consistent with the RBV theory that the accumulation of intangible
assets by a new firm affects its market value (Dierickx and Cool, 1989); and suggests that

arguments that resources are less relevant for the competitive advantage of firms in dynamic

environments (Eisenhardt and Martin, 2000) may overlook the role that resources play in

substantiating a firm‟s claims to value. Our findings suggest “resources matter” for investors‟

valuations of new firms, but that their effects need to considered in combination with the market

actions of a firm. For example, as hypothesized, we find, that investments in R&D have a

positive effect on a firm‟s market value through their interaction with new product

announcements. In contrast, the direct effect of investment in R&D is negative and significant,
which is consistent with past research (e.g. Erickson and Jacobson, 1992). According to these

                                                                         Enacting Market Value

authors this negative relationship is consistent with an explanation that the stock market treats

investments in R&D as an expense that reduces a firm‟s short-term profitability. Our results,

however, suggest that investors‟ interpretations of a firm‟s investments in R&D may vary in the

presence or absence of “innovative output,” such as new product announcements. Further, in

contexts characterized by high levels of ambiguity new product announcements can be viewed as

a form of experimentation, which enables a new firm to learn rapidly and discover how to

combine resources in valuable ways ahead of competitors (Rindova and Kotha, 2001). Therefore,

the presence of high levels of new product introductions may lead investors to expect that the

firm will derive greater benefits from its investments in R&D than its competitors. These

observations suggest the need for future research on the effects of different combinations of

strategic choices on stakeholder evaluations.

    The importance of extending research efforts in this direction is underscored by our finding

that new product announcements had a negative interaction with downstream investments in

marketing. This finding was contrary to our predictions. Several explanations for this observed

relationship are possible: First, investments in marketing assets may be seen as incompatible

with an innovation-based strategy, as signaled through the new product announcements of a firm.

In other words, investors may be concerned that a new firm is spreading itself to thin by seeking

to compete both through innovation and marketing. Alternatively, new product announcements
and investments in marketing may be seen as substitutes, as two alternative sources of

information about a firm‟s efforts to attract attention to its products, and the contribution of each

to the enactment of a new firm‟s market value may reduced by the presence of the other.

    The positive interaction we expect and find between products announcements and partnering

is consistent with a vast body of research that has shown the various resource and legitimacy

benefits that new firms derive from their affiliations (e.g., Benjamin and Podolny, 1999; Stuart,

et al. 1999). Our contribution with regard to understanding the role of partnering in the

enactment of the value of new firms is to show how it fits within this broader framework for
understanding how new firms enact their market value. It is important to highlight, however, that

                                                                          Enacting Market Value

partnering had the largest positive coefficient, both in terms of the direct and indirect effects,

providing evidence that extant research has indeed identified one of the most important factors

affecting investors‟ valuations of new firms.

       Finally, the positive interaction we find between new product announcements and

managerial accounts about a firm‟s unobservable sources of competitive advantage provides

strong evidence for the importance of strategic communications from new firms to their

stakeholders in emerging industries. While some researchers have argued that communications

may be one of the most important activities for entrepreneurs in emerging industries (Aldrich and

Fiol, 1994), to the best of our knowledge this idea has not been tested empirically. Our models

indicate both a significant direct and indirect effect of managerial accounts about sources of

competitive advantage, suggesting that such accounts influence investors‟ perceptions of the

value-creating potential of a firm both directly, and indirectly – through their substantiating

effect with respect to the firm‟s claims to value. Given that our goal was to develop a

comprehensive model of the process through which new firms enact their market value, we did

not examine multiple aspects of these accounts that can influence investor sensemaking. For

example, future research may focus more specifically on whether the extent to which firms

articulate their mental models of value creation in the industry has additional effects on

investors‟ valuation of the firm.
    Overall, our paper proposes an integrative theoretical perspective for understanding how

new firms in emerging industries enact their market value. Our ideas and findings have important

implications for both theory and practice. In terms of practice, our findings suggest that even

under conditions of extreme ambiguity and turbulence, firms can influence investor perceptions

of their ability to create value. In particular we identify two processes that make up the value

enactment process: a) claiming value through actions that signal the innovation strategy of the

firm; and b) substantiating these claims through intangible assets, relationships, and accounts, all

of which serve as communication resources that make more information about the firm available
to investors. These two processes captured in our model of enactment of market value explain

                                                                         Enacting Market Value

9% of the variance in market valuations of Internet firms, which have been often viewed as

epitomes of investors‟ irrationality (Cooper et al., 2001). In contrast, our findings suggest that

investors responded to the communicative efforts of smart managers who recognized the need to

not only make claims about the value-creating potential of their firms, but also to substantiate

these claims.

                                                                      Enacting Market Value


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                                                                                                                       Enacting Market Value

                                                                       TABLE 1
                      Means, Standard Deviations, and Pearson Correlation Coefficients for Study Variables

                     Mean        S.D.      Min       Max         (1)       (2)        (3)       (4)       (5)        (6)       (7)     (8)      (9)

(1)   Tobin's q        6.73      11.79     -0.54     104.22

(2)   Firm Age         3.30       1.95           0       10     -0.10
      Firm Size
(3)   (ln Sales)       4.58       1.48           0    10.55      0.01       0.47

(4)   Cash           127.65    248.53            0    2490       0.03       0.41      0.54

(5)   Boom             0.56       0.50           0         1     0.35      -0.40     -0.27      -0.13

(6)   R&D             32.03      51.93           0      303      0.04       0.55      0.62       0.64     -0.23

(7)   SG&A           157.23    245.62            0    9596       0.03       0.50      0.71       0.76     -0.23       0.85

(8)   Intangibles      4.20       1.04           0         6     0.02      -0.07      0.14       0.09     -0.15       0.05      0.07

(9)   Partnering       5.74       9.35           0       65      0.33      -0.04      0.17       0.20      0.28       0.26      0.29   0.11

(10) Innovation        2.73       4.54           0       27      0.24       0.01      0.22       0.27      0.26       0.23      0.25   0.09         0.59

N = 214 firm years (listwise).
Two-tailed test of significance; all correlations with an absolute value greater than 0.135 are significant at p < 0.05 or smaller.

                                                                         Enacting Market Value

                                         TABLE 2
        Results of GLS Regression Analysis with Firm-Fixed Effects

                                             Model 1          Model 2            Model 3

Firm Fixed Effects                           included         included           included

Firm Age                                     1.4036           1.3603             -0.6822
                                             (2.1480)         (2.1302)           (2.2617)
Firm Size                                    -7.2915**        -7.4002**          -8.7376**
                                             (3.0207)         (2.9775)           (2.9857)
Cash                                         -0.5650          -0.5477            1.7121*
                                             (0.8281)         (0.8252)           (0.9245)
Boom                                         1.7767†          1.5284†            2.1335*
                                             (1.1182)         (1.1162)           (1.0643)
R&D                                          -3.3410**        -3.6226**          -4.2068***
                                             (1.1858)         (1.1676)           (1.1472)
SG&A                                         -2.6042          -2.4648            1.9829
                                             (3.6924)         (3.4761)           (2.9442)
Intangibles                                  1.6904*          1.7480*            1.8245*
                                             (0.8395)         (0.8175)           (0.7931)
Partnering                                   2.1070*          1.6858*            -1.6262†
                                             (1.1315)         (0.7888)           (1.5560)
Innovation                                                    0.9957             -2.3733*
                                                              (1.4624)           (1.1147)
Innovation x R&D                                                                 1.7136*
Innovation x SG&A                                                                -9.6794***
Innovation x Intangibles                                                         1.0405*
Innovation x Partnering                                                          1.9105***

Adjusted R2                                  0.31             0.31               0.40
Improvement over base (Δ adj. R2)                             0.00               0.09***

       † p < 0.10; * p < 0.05; ** p < 0.01; *** p < 0.001.
       White heteroscedasticity-consistent standard errors are in parentheses.

                                                         Enacting Market Value

FIGURE 1. Theoretical Model

                     Upstream Investments

 Downstream Investments

                                            Process of
 New Product                                                    Market Value
 Announcements                              Enacting

 Strategic Partnerships

                     Managerial Accounts