I NNOVATION , G ROWTH , AND F INANCIAL M ARKETS Leonid Kogan1 1

MIT and NBER

SQA, 2015

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

K EY QUESTIONS

How does uncertainty around technological progress affect equity markets and equity investors?

K EY QUESTIONS

How does uncertainty around technological progress affect equity markets and equity investors? Why may value stocks earn higher returns than growth stocks on average?

K EY QUESTIONS

How does uncertainty around technological progress affect equity markets and equity investors? Why may value stocks earn higher returns than growth stocks on average? Who invests and who should invest in growth firms?

I NNOVATION SHOCKS NEGATIVELY AFFECT STOCK MARKET VALUE OF EXISTING FIRMS

Market excess return

0.4 0.2 0 −0.2 −0.4 −0.5

0 0.5 Innovation shock

G ROWTH FIRMS ARE LESS VULNERABLE TO INNOVATION RISK 1950-2008

Market to book Market‐to‐book

Past investment Past investment

0.15 0.05 ‐0.05 ‐0.15 ‐0.25 0 25

Lo

2

3

4

5

6

7

8

9

Hi

I NVESTORS WITH LONGER HORIZON AND MORE HUMAN CAPITAL OVERWEIGH GROWTH

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

I NTRODUCTION Technological innovation is an important source of economic growth

I NTRODUCTION Technological innovation is an important source of economic growth

Cost in 2010 dollars ,→ $ 5,000; state-of-the-art IBM server

I NTRODUCTION Technological innovation is an important source of economic growth

Cost in 2010 dollars ,→ $ 5,000; state-of-the-art IBM server ,→ $ 5,100,000; Burroughs 205, in 1960

I NTRODUCTION Technological innovation is an important source of economic growth

Cost in 2010 dollars ,→ $ 5,000; state-of-the-art IBM server ,→ $ 5,100,000; Burroughs 205, in 1960 ,→ $ 160,833,333; computer with same CPU power as IBM server, in 1960

I NNOVATION CYCLES ARE NOT BUSINESS CYCLES Different horizon: innovation cycles occur at lower frequency

I NNOVATION CYCLES ARE NOT BUSINESS CYCLES Different horizon: innovation cycles occur at lower frequency Different timing: innovation booms need not coincide with business cycle booms

I NNOVATION CYCLES ARE NOT BUSINESS CYCLES Different horizon: innovation cycles occur at lower frequency Different timing: innovation booms need not coincide with business cycle booms Field (2003) “the years 1929-1941 were, in the aggregate, the most technologically progressive of any comparable period in U.S. economic history.” “... throughout the Depression, behind the dramatic backdrop of continued high unemployment, technological and organizational innovations were occurring across the American economy, especially but not exclusively in chemical engineering (including petrochemicals and synthetic rubber), aeronautics, electrical machinery and equipment, electric power generation and distribution, transportation, communication, and civil/structural engineering ...”

I NNOVATION CYCLES ARE NOT BUSINESS CYCLES Different horizon: innovation cycles occur at lower frequency Different timing: innovation booms need not coincide with business cycle booms Field (2003) “the years 1929-1941 were, in the aggregate, the most technologically progressive of any comparable period in U.S. economic history.” “... throughout the Depression, behind the dramatic backdrop of continued high unemployment, technological and organizational innovations were occurring across the American economy, especially but not exclusively in chemical engineering (including petrochemicals and synthetic rubber), aeronautics, electrical machinery and equipment, electric power generation and distribution, transportation, communication, and civil/structural engineering ...”

T ECHNOLOGICAL ADVANCES CREATE WINNERS AND LOSERS

Schumpeter (1942) and creative destruction

T ECHNOLOGICAL ADVANCES CREATE WINNERS AND LOSERS

Schumpeter (1942) and creative destruction Benefits and costs are asymmetrically distributed

T ECHNOLOGICAL ADVANCES CREATE WINNERS AND LOSERS

Schumpeter (1942) and creative destruction Benefits and costs are asymmetrically distributed ,→ innovators versus investors in existing firms

T ECHNOLOGICAL ADVANCES CREATE WINNERS AND LOSERS

Schumpeter (1942) and creative destruction Benefits and costs are asymmetrically distributed ,→ innovators versus investors in existing firms ,→ labor versus vs owners of physical capital

T ECHNOLOGICAL ADVANCES CREATE WINNERS AND LOSERS

Schumpeter (1942) and creative destruction Benefits and costs are asymmetrically distributed ,→ innovators versus investors in existing firms ,→ labor versus vs owners of physical capital ,→ “growth” versus “value” firms

E XAMPLE : R AILROADS DISPLACED WATER TRANSPORTATION

“The early opinion that railroads could not compete with waterways gave ground before practical proofs to the contrary. . . during the last few years of rapid progress in railroad building no new canals were planned, and those which existed near railroads had decreased in their receipts from 33 to 66 percent.” Balthasar H. Meyer, 1917, Transportation in the United States before 1860, Ch. 17 p. 553

E XAMPLE : AUTOMOBILES DISPLACED RAILROADS

“The triumph of the private passenger car over rail transportation in the United States was meteoric. Passenger miles traveled by automobile were only 25 percent of rail passenger miles in 1922 but were twice as great as rail passenger miles by 1925, four times as great by 1929.” James J. Flink, 1990, The Automobile Age, Ch. 19 p. 360

I NNOVATION POSES RISK TO INVESTORS IN OLD - TECHNOLOGY FIRMS

In 1900, railroads account for over 50% of market cap of all NYSE firms

I NNOVATION POSES RISK TO INVESTORS IN OLD - TECHNOLOGY FIRMS

In 1900, railroads account for over 50% of market cap of all NYSE firms Between 1927 and 1975, go from 23% to 2% of NYSE market cap

E XAMPLE : IT REVOLUTION IT revolution 1972–1974 reduces stock market values of incumbent firms

Hobijn, B., and B. Jovanovic “The Information-Technology Revolution and the Stock Market: Evidence,” American Economic Review 2001

IT- HEAVY SECTORS DECLINE THE MOST

1996 IT capital share

1972–1974 drop 

1998 incumbent share

90.0 80.0 70.0 60.0 50.0 40.0 30.0 20 0 20.0 10.0 0.0 Manufacturing

Transportation,  Finance, Insurance,  Communication  and Real Estate and Public Utilities

Services

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

G ROWTH FIRMS CAN HELP HEDGE INNOVATION SHOCKS

Firms and investors are exposed to disruptive innovation shocks

G ROWTH FIRMS CAN HELP HEDGE INNOVATION SHOCKS

Firms and investors are exposed to disruptive innovation shocks Public market index does not protect investors from displacement by innovation

G ROWTH FIRMS CAN HELP HEDGE INNOVATION SHOCKS

Firms and investors are exposed to disruptive innovation shocks Public market index does not protect investors from displacement by innovation Growth firms derive more value from growth opportunities; value firms – from assets in place

G ROWTH FIRMS CAN HELP HEDGE INNOVATION SHOCKS

Firms and investors are exposed to disruptive innovation shocks Public market index does not protect investors from displacement by innovation Growth firms derive more value from growth opportunities; value firms – from assets in place Innovation shocks are beneficial to growth opportunities, increase prices of growth firms relative to value firms

G ROWTH FIRMS CAN HELP HEDGE INNOVATION SHOCKS

Firms and investors are exposed to disruptive innovation shocks Public market index does not protect investors from displacement by innovation Growth firms derive more value from growth opportunities; value firms – from assets in place Innovation shocks are beneficial to growth opportunities, increase prices of growth firms relative to value firms Growth tilt can be a hedge

I NNOVATION RISK CAN GIVE RISE TO VALUE PREMIUM

Growth firms can provide a hedge

I NNOVATION RISK CAN GIVE RISE TO VALUE PREMIUM

Growth firms can provide a hedge Growth firms trade at higher valuations

I NNOVATION RISK CAN GIVE RISE TO VALUE PREMIUM

Growth firms can provide a hedge Growth firms trade at higher valuations Positive value premium in the cross-section of stock returns

A ND SOME EQUATIONS ... stochastic discount factor, πt = exp

Z

t

0

 f˜J (Cs , C¯s , Js ) ds f˜C (Ct , Ct , Jt ),

where γ−θ −1

−1

−θ hC,ts = ρ(eχt )−ˆγ b−γ f (ωt ) γ−1 ts l(ωt )   θ−1 1−φ ˆl(ωt ) l(ωt ) ≡ (1 − LI (ωt )) − (1 − φ)(1 − LI (ωt ))−φ (1 − LI (ωt ))−h(1−φ)

γˆ ≡ γ(1 − h) + 1    1−θ−1 1−θ −1 ρ (f (ωt )) γ−1 + (1 − γ) . (γ − θ−1 ) ˆl(ωt ) 1 − θ−1

hJ (C, J) = −

(A.8) (A.9) (A.10) (A.11)

Next, we determine the value of assets in place and growth opportunities. First, we solve for the two functions P and P˜ that determine the value of existing projects (34) Pt = φ eχt Kt−1 P˜t = φ eχt Kt−1

 

−1

γ−θ −1 γ−1

−1

γ−θ −1 γ−1

l(ωt )−θ f (ωt ) l(ωt )−θ f (ωt )

−1 −1

ν(ωt )

(A.12)

ν˜(ωt ),

(A.13)

where ν(ω) and ν˜(ω) solve the ODEs −1

0 = (1 − LI (ω))1−φ l(ω)−θ f (ω) −θ−1

0 = (1 − LI (ω))1−φ l(ω)

f (ω)

γ−θ −1 γ−1 γ−θ −1 γ−1

+ ρν (ω)ν(ω) + A ν(ω)

(A.14)

+ (ρν (ω) − θu ) ν˜(ω) + A ν˜(ω),

(A.15)

and the function ρν is given by   1−θ −1 ρ −1 ρν (ω) = − (γ − θ−1 )ˆl(ωt )1−θ f (ωt ) γ−1 + (1 − γ) + γµ(b(ω) − 1)+ 1 − θ−1
1 + (1 − γ)φ − 1 λ1−α eω LI (ω)α + (1 − h)(1 − γ)((1 − φ)µx − φδ) + (1 − γ)2 (1 − h)2 (1 − φ)2 σx2 . 2

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

U SE PATENTS TO MEASURE INNOVATION

Cover patented innovations

U SE PATENTS TO MEASURE INNOVATION

Cover patented innovations Patents differ in economic value – most patents have little value

U SE PATENTS TO MEASURE INNOVATION

Cover patented innovations Patents differ in economic value – most patents have little value In the literature it is common to weight patents by forward citations... ,→ ...we need an economic measure of private value

U SE PATENTS TO MEASURE INNOVATION

Cover patented innovations Patents differ in economic value – most patents have little value In the literature it is common to weight patents by forward citations... ,→ ...we need an economic measure of private value

Follow approach similar to Kogan, Papanikolaou, Seru and Stoffman, “Technological Innovation, Resource Allocation, and Growth,” 2012 ,→ Infer value added associated with a patent by firm’s stock market reaction to patent issue

C ONSTRUCT PATENT DATA

Build a measure of innovation from the ground up, by combining a database of patent filings and issues with stock return data

C ONSTRUCT PATENT DATA

Build a measure of innovation from the ground up, by combining a database of patent filings and issues with stock return data Download the entire history of U.S. patent documents from Google Patents (7.8 million patents): ,→ Google provides text (OCR) version of patent documents

C ONSTRUCT PATENT DATA

Build a measure of innovation from the ground up, by combining a database of patent filings and issues with stock return data Download the entire history of U.S. patent documents from Google Patents (7.8 million patents): ,→ Google provides text (OCR) version of patent documents

Match patents to publicly traded firms using text analysis algorithms

1.9 M ILLION MATCHED PATENTS

I SOLATE ECONOMIC VALUE OF A PATENT USING STOCK MARKET REACTION

Every Tuesday, the USPTO publishes the Official Gazette describing newly granted patents ,→ Focus on 3-day window: [t, t + 2] around patent grant day

I SOLATE ECONOMIC VALUE OF A PATENT USING STOCK MARKET REACTION

Every Tuesday, the USPTO publishes the Official Gazette describing newly granted patents ,→ Focus on 3-day window: [t, t + 2] around patent grant day

On patent grant day market learns application is successful ,→ Assume that quality of patent is public information prior to patent grant

I SOLATE ECONOMIC VALUE OF A PATENT USING STOCK MARKET REACTION

Every Tuesday, the USPTO publishes the Official Gazette describing newly granted patents ,→ Focus on 3-day window: [t, t + 2] around patent grant day

On patent grant day market learns application is successful ,→ Assume that quality of patent is public information prior to patent grant

On issue day, stock price should increase in proportion to patent value

E XAMPLE : P ROTEIN D ESIGN A broad patent is spurring the shares of Protein Design Lab. - New York...

http://www.nytimes.com/1996/12/20/business/a-broad-patent-is-spurring...

Business Day A broad patent is spurring the shares of Protein Design Lab. By Lawrence M. Fisher Published: December 20, 1996

SHARES of Protein Design Labs Inc. have gained nearly 25 percent since the company disclosed on Monday that it had been awarded a broad patent covering the production of so-called humanized antibodies in mice. Despite the sharp rise, some analysts say the company's shares are still a compelling buy, based not only on the prospect for royalties created by the patent, but also on Protein Design's own product pipeline. The awarding of the patent, which could affect as much as a fourth of all biotechnology drugs currently in clinical trials, is the second recent hit for Protein Design after a big miss last year. In September, the company, based in Mountain View, Calif., reported that a drug it developed with Hoffmann LaRoche, a unit of Roche Holding, had proved effective in preventing the rejection of transplanted kidneys in human trials. The same drug had failed an earlier trial for graft versus host disease, a common complication of bone marrow transplants. Shares in Protein Design Labs rose 53.125 cents yesterday, to $34.25, in Nasdaq trading. On Wednesday, the stock rose $2.21875, and gained $4 on Tuesday. The stock had traded as low as $12 after last summer's disappointment. Matthew Geller, an analyst with Oppenheimer & Company, has maintained Protein Design Labs as a strong buy. He said that the company had both broad enabling technology that could produce drugs for many different diseases and a sound business strategy of using multiple corporate partners, which has allowed it to build a pipeline of several drug candidates while conserving its financial resources. ''It is one of the few companies with a platform,'' Mr. Geller said. ''It's one of the few biotech companies with sufficient backbone to become a major pharmaceutical company.'' He noted that the stock had traded in the mid-30's two years ago, and since then the company had added nine corporate partners and had a drug that could reach the market as soon as next year. That drug is Zenapax, which will be produced and marketed by Roche for kidney transplant, with Protein Design receiving a 15 percent royalty on sales. Roche is also conducting clinical trials of Zenapax in psoriasis and uveitis, two autoimmune diseases, which would be far larger markets. Close behind Zenapax in the clinic are a drug for various leukemias, in partnership with Kanebo; a drug for cytomegalovirus in transplants and in AIDS patients, and a drug for chronic hepatitis B and liver transplant, with Boehringer Mannheim and Sandoz, all of which are in the second of

E XAMPLE : P ROTEIN D ESIGN 160

4

150

3.5

140

3

130

2.5

120

2

110

1.5

100

1

90

0.5

80

0 -4

-3

-2

-1

0

1

2

3

4

5

6

7

Trading Days

Cumulative abnormal return (left) and trading volume (right) around issue date

E XAMPLE : IBM

S TOCK MARKET PREDICTS FUTURE PATENT CITATIONS

log forward citations

4 2 0

−2 −4 −4

−2 0 2 log patent market value ($m 1982)

4

R OTATING LEADERSHIP Innovation

−1 −2 −3 −4 1920

1940

1960 1980 year

2000

R OTATING LEADERSHIP Innovation

−1 −2 −3 −4 1920 ’30s

1940

1960 1980 year

2000

Automobiles, telecommunication General Motors, AT&T

R OTATING LEADERSHIP Innovation

−1 −2 −3 −4 1920

1940

1960 1980 year

2000

’30s

Automobiles, telecommunication General Motors, AT&T

’60s, early ’70s

Chemicals, oil and computing/electronics IBM, GE, 3M, Exxon, Eastman Kodak, du Pont, Xerox

R OTATING LEADERSHIP Innovation

−1 −2 −3 −4 1920

1940

1960 1980 year

2000

’30s

Automobiles, telecommunication General Motors, AT&T

’60s, early ’70s

Chemicals, oil and computing/electronics IBM, GE, 3M, Exxon, Eastman Kodak, du Pont, Xerox

’90s, ’00s

Computer hardware and software Sun Microsystems, Oracle, Dell, Intel, IBM, AT&T, Cisco, Microsoft, Apple

I NNOVATION SPIKES HURT EXISTING FIRMS Stock market - TBills, 1950-2008

0.4

Return

0.2 0 −0.2 −0.4 −0.5 0 0.5 Innovation shock

I NNOVATION SPIKES HURT EQUITY INVESTORS 1982 - 2002 Consumption

Relative consumption

0.2 2-yr growth

0.2 0.1

0.1

0

0

−0.1

−0.1 −0.5 0 0.5 Innovation shock

−0.5 0 0.5 Innovation shock

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

F IRM CHARACTERISTICS AND GROWTH OPPORTUNITIES

Firms with rich growth opportunities have higher exposure to innovation shocks ,→ But growth opportunities are unobservable...

F IRM CHARACTERISTICS AND GROWTH OPPORTUNITIES

Firms with rich growth opportunities have higher exposure to innovation shocks ,→ But growth opportunities are unobservable...

Growth opportunities are positively correlated with observable firm characteristics ,→ market-to-book, investment rate, ...

AVERAGE EXCESS RETURNS 1950-2008

Market to book Market‐to‐book

Past investment Past investment

2

6

14 12 10 8 6 4 2 0 Lo L

3

4

5

7

8

9

Hi

I T IS NOT ALL ABOUT MARKET RISK CAPM alphas, 1950-2008

Market to book Market‐to‐book

Past investment Past investment

5 3 1 ‐1 ‐3 ‐5 5

Lo

2

3

4

5

6

7

8

9

Hi

G ROWTH FIRMS ARE LESS VULNERABLE TO INNOVATION RISK 1950-2008

Market to book Market‐to‐book

Past investment Past investment

0.15 0.05 ‐0.05 ‐0.15 ‐0.25 0 25

Lo

2

3

4

5

6

7

8

9

Hi

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

W HO ARE THE VALUE / GROWTH INVESTORS ? Everyone cannot have the same tilt: investors collectively hold the market

W HO ARE THE VALUE / GROWTH INVESTORS ? Everyone cannot have the same tilt: investors collectively hold the market Growth tilt makes sense for some, value tilt for others

W HO ARE THE VALUE / GROWTH INVESTORS ? Everyone cannot have the same tilt: investors collectively hold the market Growth tilt makes sense for some, value tilt for others Sodini, P., S. Betermier and L. Calvet, “Who are the Value and Growth Investors?”, 2013 ,→ Use Swedish household data

W HO ARE THE VALUE / GROWTH INVESTORS ? Everyone cannot have the same tilt: investors collectively hold the market Growth tilt makes sense for some, value tilt for others Sodini, P., S. Betermier and L. Calvet, “Who are the Value and Growth Investors?”, 2013 ,→ Use Swedish household data

“Value investors are substantially older, tend to have higher financial wealth, higher real estate wealth, lower leverage, lower income risk, lower human capital, and are also more likely to be female, than the average growth investor.” “By contrast, males, entrepreneurs, and educated investors are more likely to invest in growth stocks.”

W HO ARE THE VALUE / GROWTH INVESTORS ? Everyone cannot have the same tilt: investors collectively hold the market Growth tilt makes sense for some, value tilt for others Sodini, P., S. Betermier and L. Calvet, “Who are the Value and Growth Investors?”, 2013 ,→ Use Swedish household data

“Value investors are substantially older, tend to have higher financial wealth, higher real estate wealth, lower leverage, lower income risk, lower human capital, and are also more likely to be female, than the average growth investor.” “By contrast, males, entrepreneurs, and educated investors are more likely to invest in growth stocks.”

This figure illustrates the value loading of the stock portfolio for different cohorts of households. Each solid line corresponds to a given cohort, defined as a 5-year age bin. The first cohort contains households with a head aged between 30 and 34 in 1999, while the oldest cohort h has h a head h d aged d between b 70 and d 74 in i 1999. 1999 The Th loadings l di off allll households h h ld in i year t are demeaned d d to controll for f changes h i the in h composition of the Swedish stock market. A cohort’s loading in year t is the wealth-weighted average year-t loading of households in the cohort. The figure is based on the panel of all Swedish direct stockholders over the 1999 to 2007 period.

O LDER INVESTORS HAVE A VALUE TILT 1999 to 2007

04 0.4

0.3

Value Lo oading

02 0.2

0.1

0

-0.1

-0.2 02

-0.3

-0.4 04 30

35

40

45

50

55

Age

60

65

70

75

T ECHNOLOGICAL INNOVATION PLACES HUMAN CAPITAL AT RISK

Brynjolfsson, E., A. McAfee, “New World Order: Labor, Capital, and Ideas in the Power Law Economy.” Foreign Affairs, July/August 2014 “... the real winners of the future will not be the providers of cheap labor or the owners of ordinary capital, both of whom will be increasingly squeezed by automation. Fortune will instead favor a third group: those who can innovate and create new products, services, and business models.”

T ECHNOLOGICAL INNOVATION PLACES HUMAN CAPITAL AT RISK

Brynjolfsson, E., A. McAfee, “New World Order: Labor, Capital, and Ideas in the Power Law Economy.” Foreign Affairs, July/August 2014 “... the real winners of the future will not be the providers of cheap labor or the owners of ordinary capital, both of whom will be increasingly squeezed by automation. Fortune will instead favor a third group: those who can innovate and create new products, services, and business models.”

T ECHNOLOGICAL INNOVATION PLACES HUMAN CAPITAL AT RISK

Lawrence Summers (Washington Post interview, March 3, 2015) “The rise of the top 1 percent is likely very tied up with technology. When George Eastman had a fantastic idea for photography, he got quite rich, and the city of Rochester became a flourishing city for generations, supporting thousands of middle-class workers. When Steve Jobs had had remarkable ideas, he and his colleagues made a very large fortune, but there was much less left over - there was no flourishing middle class that followed in their wake.”

T ECHNOLOGICAL INNOVATION PLACES HUMAN CAPITAL AT RISK

Lawrence Summers (Washington Post interview, March 3, 2015) “The rise of the top 1 percent is likely very tied up with technology. When George Eastman had a fantastic idea for photography, he got quite rich, and the city of Rochester became a flourishing city for generations, supporting thousands of middle-class workers. When Steve Jobs had had remarkable ideas, he and his colleagues made a very large fortune, but there was much less left over - there was no flourishing middle class that followed in their wake.”

T ECHNOLOGICAL INNOVATION PLACES HUMAN CAPITAL AT RISK

Lawrence Summers (Washington Post interview, March 3, 2015) “The rise of the top 1 percent is likely very tied up with technology. When George Eastman had a fantastic idea for photography, he got quite rich, and the city of Rochester became a flourishing city for generations, supporting thousands of middle-class workers. When Steve Jobs had had remarkable ideas, he and his colleagues made a very large fortune, but there was much less left over - there was no flourishing middle class that followed in their wake.”

H UMAN CAPITAL RISK AND GROWTH INVESTING

Human capital is exposed to innovation risk

H UMAN CAPITAL RISK AND GROWTH INVESTING

Human capital is exposed to innovation risk Low human capital relative to financial capital close to retirement – less exposure to innovation shocks

H UMAN CAPITAL RISK AND GROWTH INVESTING

Human capital is exposed to innovation risk Low human capital relative to financial capital close to retirement – less exposure to innovation shocks Older investors are better positioned to absorb innovation shocks, hold value stocks

C ONCLUSION

Technological shocks are a risk factor Growth stocks are a hedge, tend to have higher valuations and lower average returns Growth tilt makes sense for investors with higher exposure to innovation risk

O UTLINE K EY QUESTIONS T ECHNOLOGICAL PROGRESS AND STOCK MARKET RISK G ROWTH FIRMS ARE A HEDGE : T HEORY M EASURE I NNOVATION WITH PATENTS G ROWTH FIRMS ARE A HEDGE : E VIDENCE W HO INVESTS AND WHO SHOULD INVEST IN GROWTH A PPENDIX

C OMPETITION : ZOOM DOWN TO FIRM - LEVEL INNOVATION 1950-2008 Response of revenue to firm’s own innovation

Response of revenue to competitor innovation

0.05

0.05

0

0

−0.05

−0.05 0

2

4 Years

6

8

0

2

4 Years

6

8

G ROWTH FIRMS ARE MORE ROBUST 1950-2008 Low- vs High-M/B response to competitor innovation

Low- vs High-inv. response to competitor innovation

0

0

−0.02

−0.02

−0.04

−0.04 0

2

4 Years

6

8

0

2

4 Years

6

8