Corporate Governance and Innovation: Theory and Evidence

We develop a theory to show how external and internal corporate governance mechanisms affect innovation. We show that there is a U-shaped relation between innovation and external takeover pressure, which arises from the interaction between expected takeover premia and private benefits of control. We show strong empirical support for the predicted relation using ex-ante and ex-post innovation measures. We exploit the variation in takeover pressure created by the passage of anti-takeover laws across different states. Innovation is fostered either by an unhindered market for corporate control or by anti-takeover laws that are severe enough to effectively deter takeovers.