The Threat of Shareholder Intervention and Firm Innovation∗

This research demonstrates that the threat of shareholder intervention negatively affects firm manager innovation incentive. The underlying mechanism is that innovation may cause stock price to reflect less accurate information about a firm’s fundamental value, which makes firm managers vulnerable to shareholder intervention. Firm managers under the threat of shareholder intervention will be biased against innovation projects to minimize job termination risk. Consistent with this mechanism, I find that (1) increasing the threat of shareholder intervention has a significant and economically important negative impact on firm innovation; (2) the threat of shareholder intervention exerts less negative effects on firms that are more likely to have efficient stock prices—firms with more monitoring institutional investors and/or more financial analysts. To establish causality, I exploit a novel identification strategy that relies on a quasi-natural experiment of activist investor closures to generate exogenous variation in the threat of shareholder intervention. The results from the difference-in-differences estimation show that firm-level innovation significantly improves following exogenous activist investor closures. This identification strategy suggests a negative causal effect of shareholder intervention threat on firm innovation.