How new product announcements affect share price and sales

New product announcements (NPAs) represent a form of voluntary, non-financial disclosure that companies routinely make to let investors and customers know what’s in the pipeline. These details are unrelated to results presentations and are not well studied by academics. But how do these announcements – and the extent of such announcements – affect stock prices?

Research co-authored by Jenny Chu, Associate Professor of Accounting at Cambridge Judge Business School, has found that stock prices react more favourably to NPAs that contain more extensive disclosure about a company’s innovation, and that a higher level of innovation disclosure predicts a larger increase in future sales.

However, the research also finds that this ability to predict sales is reduced when managers have stronger incentives to maximise their personal wealth through stock sales or other activities, and also when there is weaker corporate governance or weaker bargaining power by customers.

Why word count is a key metrics for product announcements

“The research provides a tool to examine how new product announcements are interpreted in the market and in a way that can apply to many types of companies,” says Jenny, whose research is detailed in a study published in the Reviewof Accounting Studies journal. “We found a clear connection between the extent of such disclosure and future performance as measured by both sales and share price movement.”

The research develops a novel new measurement based on a word count in each NPA that reflects a newly constructed dictionary of innovation-related words, which Jenny believes is more generalisable and informative for firm value and future performance than more traditional measures of innovation that reflect patents or spending on research and development. That’s because some industries have very little R&D or patent-development activities, and because the new measure directly quantifies the innovation level in new products that actually make it to market rather than also including those left on the drawing board whether awarded a patent or not.

Stock market reaction is linked to the level of innovation disclosure

“This novel method allowed us to examine to which degree managers use innovation-related words to describe new products beyond those conventional inputs such as patents,” says Jenny. “This information is clearly important to investors and other stakeholders, as our research shows that a higher level of innovation disclosure in an NPA is linked to a greater stock market reaction to the information.”

According to the research, a one-standard-deviation from the mean (of the study sample) increase in the extent of innovation disclosure is associated with a 23% higher market reaction in a three-day window around such an announcement and an increase of about 1.22% in a company’s next year’s sales deflated by assets, an average increase of $328 million in sales based on the study sample. The association of greater information disclosure with higher future sales is “consistent with innovation disclosure capturing the value of the new product to customers”, the research says.

“Our measure is based on NPAs reflecting managerial innovation assessments issued across a diverse set of industries, controlling for R&D expenses and patent developments. As such, our study may enable firm stakeholders and academic scholars to better understand the performance and valuation implications of these voluntary, non-financial innovation disclosures,” says the research.

Three factors that can disrupt market impact predictions

“Product innovation is an important signal of firm value for capital market investors and also helps firms secure market share in the product market,” say Jenny and her colleagues in the research. “To enhance transparent communication between informed managers and a wide range of stakeholders, managers use NPAs to provide crucial contextual information about new product innovation and benefits.”

Jenny has examined disclosure-related issues in some of her previous research, including studies about market manipulation and executive compensation. She says the topic of disclosure in new product innovation interested her because “it is a form of voluntary managerial disclosure with real future performance implications and is previously little studied by the academic literature.”

Creative, fresh, inventive? Examining the language used when new products are announced

The research’s methodology is based on a complete list of US firms in the Capital IQ Key Developments database listed on either the New York Stock Exchange or American Stock exchange between 2001 and 2016, and a summary of news events, regulatory announcements and other material related to those firms’ product development through headlines such as ‘unveil’, ‘launch’ and ‘new product’.

The findings are based on a final sample of 28,076 firm-day observations containing at least one NPA that could be tested for future performance market reaction, controlled for industry-level technological progress by including number of patents, patent citations and patent value.

Among those NPAs are 61 words or inflections describing innovation, including advanced, creative, fresh, inventive, pioneering and seminal. Perhaps not surprisingly, business equipment is the industry with the most innovation-related NPAs given how important innovation is to that sector, followed by healthcare, finance, telecommunications and manufacturing.

NPAs “provide customers and investors with a foundational understanding of both the existence and features of new products,” says the research. “For example, managers may use NPAs to explain why a new product is innovative, position the new product within the portfolio of the firm’s other products, or educate consumers about technological advancements that can cater to their evolving needs.

“These disclosures can also clarify how new products compare with competing products in the market to facilitate customers’ buying decisions. Innovation disclosures can also provide investors with insights into potential future revenue streams and profits from a new product, thereby enhancing their understanding of a firm’s position in the competitive landscape and informing their investment decisions.”

The study – entitled “New product announcements, innovation disclosure, and future firm performance” – is co-authored by Jenny Chu of Cambridge Judge Business School, Yuan He of Xiamen University in China, Kai Wai Hui of the University of Hong Kong, and Reuven Lehavy of the University of Michigan.