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North American Journal of Economics
and Finance
journal homepage: www.elsevier.com/locate/najef
Knowledge capital, CEO power, and firm value: Evidence from the
IT industry
Junmao Chiu
a
, Chin-Ho Chen
b,⁎
, Chung-Chieh Cheng
c
, Shih-Chang Hung
c
a
College of Management, Yuan Ze University, 135 Yuan-Tung Road, Chung-Li, Taoyuan 32003, Taiwan
b
Department of Finance, Feng Chia University, 100 Wenhwa Road, Taichung 40724, Taiwan
c
Graduate Program of Finance, Department of Information Management and Finance, National Chiao Tung University, 1001 Ta-Hsueh Road, Hsinchu
30050, Taiwan
ARTICLE INFO
Classification codes:
G3
G30
G34Keywords:
Knowledge capital
CEO power
Powerful CEO
Firm value
Disruptive innovation
ABSTRACT
Disruptive innovation dramatically changes the demand of a product market in the information
technology (IT) industry. In response to the impact of disruptive innovation, IT firms that may be
eliminated from the competitive race actively develop innovative products and adjust their operating
strategies to strengthen their survivability in the fiercely competitive market. Thus, this study ex-
plores the factors that affect firm value in the IT industry under the impact of disruptive innovation.
The empirical results reveal that knowledge capital and CEO power play crucial roles in explaining
firm value. IT firms with powerful CEOs and increased knowledge capital have high firm values. The
effects of knowledge capital and CEO power on firm value are especially significant for founder and
duality CEO firms. Furthermore, the influence of CEO power is more prominent in periods of fi-
nancial crisis.
1. Introduction
The initial success of the introduction of Apple’s iPhone in 2007 was likely explained by product superiority in the smartphone
market. Christensen, Raynor, and McDonald (2015) further posit that iPhone’s subsequent growth changed the game and was a
sustaining and disruptive innovation in the information technology (IT) industry because iPhones replaced laptops as the primary
access point to the internet. In addition, Apple introduced a new business model to link the application developers with phone users.
Based on this disruptive innovation environment, IT industry firms also confront uncertain impacts and competitive threats from
entrants and rivals. Firms have to adjust their operating strategies and make innovative products in response to the changing market
demand. If firms cannot respond to new market demand and business models, they will be eliminated from the industrial race. It is
important to understand which factors affect firm value in the IT industry under the impact of disruptive innovation.
A growing body of literature has researched how firm and board characteristics affect firm value and performance.
1
However,
https://doi.org/10.1016/j.najef.2019.101012
⁎
Corresponding author. Tel.: +886 4 24517250x4166; fax: +886 4 24513796.
E-mail addresses: jchiu@saturn.yzu.edu.tw (J. Chiu), chinhoc@fcu.edu.tw (C.-H. Chen), cccheng.iof05g@nctu.edu.tw (C.-C. Cheng),
h9020213.iof01g@g2.nctu.edu.tw (S.-C. Hung).
1
Examples are intangible assets (Clausen & Hirth, 2016;Peters & Taylor, 2017), CEO power (Dowell et al., 2011;Yang & Zhao, 2014;Han et al.,
2016), board characteristics (Adams, Akyol, & Verwijmeren, 2018;Bennouri, Chtioui, Nagati, & Nekhili, 2018;Bernile, Bhagwat, & Yonker, 2018),
directors’ attention (Chou, Chung, & Yin, 2013;Renjie & Verwijmeren, 2019), executive compensation (Bennett, Bettis, Gopalan, & Milbourn, 2017;
Coles et al., 2018), institutional shareholders (He & Huang, 2017;Kang, Luo, & Na, 2018), block shareholders (Basu, Paeglis, & Rahnamaei, 2016;
Boubaker, Nguyen, & Rouatbi, 2016), information disclosure (Sheu, Chung, & Liu, 2010;Chung, Judge, & Li, 2015), innovative efficiency
(Hirshleifer, Hsu, & Li, 2013;Gao & Chou, 2015), and industrial competition (Giroud & Mueller, 2010;Giroud & Mueller, 2011;Chen & Chen, 2012).
North American Journal of Economics and Finance xxx (xxxx) xxxx
1062-9408/ © 2019 Elsevier Inc. All rights reserved.
Please cite this article as: Junmao Chiu, et al., North American Journal of Economics and Finance,
https://doi.org/10.1016/j.najef.2019.101012
whether these factors influence firm value and performance in the IT industry under the impact of disruptive innovation remains
unknown. This study focuses on whether a higher knowledge capital can reduce the impact of firm value after the disruptive in-
novation of the iPhone and how knowledge capital and the power of a chief executive officer (CEO) affect firm value in the IT
industry. These research questions remain unknown after the disruptive innovation of the iPhone in 2007. This study seeks to fill
these gaps.
Recent studies have shown the importance of knowledge capital on competitive advantages and firm value and performance.
2
Peters and Taylor (2017) built a theoretical model to calculate a firm’s knowledge capital by spending on research and development
(R&D) because a firm's spending to develop knowledge, patents, innovative products or software is expensed as R&D. Their study
indicated that knowledge capital results in better competitive advantages and long-run benefits for firms. Hombert and Matray
(2018) and Gu (2016) showed that firms have better innovative originality and competitive advantages with a higher knowledge
capital.
In terms of the effect of knowledge capital on firm value and performance, Chan, Lakonishok, and Sougiannis (2001), Eberhart,
Maxwell, and Siddique (2004), Hsu, Reed, and Rocholl (2010), and Clausen and Hirth (2016) found that firms with a higher
knowledge capital have higher firm values and better operating performance in the long run, especially in high-tech and high-growth
firms. Peters and Taylor (2017) reported similar findings with respect to high firm values due to higher knowledge and organization
capitals. In those studies, knowledge capital can enhance firm value and performance, but the CEO is essential in a firm. Based on
above theoretical and empirical studies, we can expect that firms in the IT industry that invest in more knowledge capital will create
better competitive advantages. We further investigate whether IT industry firms with a higher knowledge capital can enhance firm
valuation after the disruptive innovation of the iPhone in 2007.
This study further links firm value to knowledge capital and the power of a CEO. Powerful CEOs have information advantages and
participate in decision-making.
3
Several studies (e.g., Fahlenbrach (2009); Dey, Engel, and Liu (2011); Gao and Jain (2011), and
Chen (2014)) found that powerful CEOs enhance the efficiency of organization and resource allocation in firms. Suitable resource
allocation can help firms that suffer from industrial competition to develop innovative products and differentiated business models to
develop better competitive advantages. In the face of exogenous shocks, Dowell, Shackell, and Stuart (2011) and Yang and Zhao
(2014) also found that firms with powerful CEOs have better performance and stronger survivability. These studies suggested that
CEO power is associated with firm value and performance, but they ignored that CEO power can combine the information advantage
from knowledge capital to affect corporate operations. Thus, we investigate the relationship among firm value, CEO power, and
knowledge capital.
In this study, we explore the effects of knowledge capital and CEO power on IT firm value under the impact of disruptive
innovation. Following Peters and Taylor (2017), we adopt R&D expenses to calculate knowledge capital in which 15% was used as
the R&D depreciation rate. CEO power is measured following Adams, Almeida, and Ferreira (2005). CEO power is a dummy variable
that equals 1 when the CEO is the founder, has duality, or is an insider. Otherwise, the value equals 0. Furthermore, firm value is
calculated using Tobin's Q.
Using the data of IT firms in the United States (US) from 2007 to 2014, our results find that firms with powerful CEOs (more
powerful CEOs) and a higher knowledge capital have higher value and better performance. This finding may be attributed to the fact
that powerful CEOs make faster and better decisions and enhance the efficiency of organization and resource utilization under the
impact of disruptive innovation. The effects of the interactions between CEO power and knowledge capital on firm value are
especially significant for founder and duality CEO firms. Similarly, we find that the interaction between CEO power and knowledge
capital is more significant in financial crisis periods than nonfinancial crisis periods. This finding suggests that powerful CEOs’
capabilities are more apparent in the crisis period.
Furthermore, our study explores the relationship between CEO power and the utilization efficiency of knowledge capital using a
two-stage least squares (2SLS) regression. The results prove that powerful CEOs enhance firm value due to better efficiency of
resources utilization. The endogeneity problem is mitigated by adding omitted variables and using Tobin’s Q
t+1
as the dependent
variable. In the endogeneity tests, our results show that firms have higher value when firms have powerful CEOs and a higher
knowledge capital.
This study contributes to the existing literature in two aspects. First, our findings indicate that CEO power and knowledge capital
play crucial roles in explaining IT firm value and performance under the impact of disruptive innovation. In particular, the inter-
actions between CEO power and knowledge capital on firm value is more significant for founder and duality CEO firms. Under a
changing competitive environment, Han, Nanda, and Silveri (2016) showed that powerful CEO firms have poor performance.
However, Dowell et al. (2011) and Yang and Zhao (2014) found that powerful CEOs firms have better performance and stronger
survivability. Although powerful CEOs may cause higher agency costs, they also may create more benefits for firms.
Second, CEOs should be more powerful in IT firms. Industrial competition is also an external governance mechanism (Chen &
Chen, 2012; Giroud & Mueller, 2010). Giroud and Mueller (2011) suggested that the benefits of corporate governance are weak in a
highly competitive industry because the CEOs are pushed to focus on corporate operations. If the CEOs are over-restrained by a
governance mechanism, they may miss business opportunities. Firms may also have higher decision-making costs. We find that IT
2
Please see Chan et al. (2001),Eberhart et al. (2004),Hsu et al. (2010),Hombert and Matray (2018),Clausen and Hirth (2016),Gu (2016),Peters
et al. (2017), and Peters and Taylor (2017).
3
Please see Brickley et al. (1997),Fahlenbrach (2009),Pathan (2009),Chikh and Filbien (2011),Dey et al. (2011),Dowell et al. (2011),Gao and
Jain (2011),Chen (2014), and Yang and Zhao (2014).
J. Chiu, et al. North American Journal of Economics and Finance xxx (xxxx) xxxx
2
firms with higher board independence have lower values, but firms with a second executive have higher values. Our findings suggest
that a second executive may be a better supervisor for IT firms.
The remainder of this study is organized as follows: Section 1 provides the introduction. Section 2 describes the hypotheses. The
sample selection and empirical model are described in Section 3.Section 4 presents the empirical and robustness results. Finally, the
conclusions are presented in Section 5.
2. Hypotheses
Knowledge capital is associated with competitive advantages. If firms have more knowledge capital, they will have higher firm
value and better operating performance, especially in the long-term (Chan et al., 2001; Eberhart et al., 2004). Gu (2016) suggested
that the innovation race is intense in highly competitive industries. Firms have better completive advantages when they have higher
knowledge capital. If firms neglect the importance of knowledge capital, they are likely to be eliminated in the industrial race. Peters,
Roberts, Vuong, and Fryges (2017) also suggested that firms benefit more from holding a higher knowledge capital in the long-term
because they apply the knowledge capital to improve their production efficiency. Thus, those firms have higher value and better
production efficiency.
Furthermore, Hsu et al. (2010) found that new IPO firms prefer to invest more resources in knowledge capital when they have low
financial constraints. IPO firms with a higher knowledge capital and a lower financial constraint are greater competitive threats to
listed firms. Hombert and Matray (2018) also showed that US firms with a higher knowledge capital decrease the threats from import
competition from China firms. If US firms possess a higher knowledge capital, firms will have better innovation originality to make
differentiated products. They also have higher sales growth and profitability. Based on these studies, we hypothesize that IT firms
have higher firm values when firms have higher knowledge capital.
Hypothesis 1:. IT firms with a higher knowledge capital have higher Tobin’s Qs.
Many studies discuss whether CEO power should be restrained by a governance mechanism. Agency theory argues that CEO
power should be restrained given the agency problem. Adams et al. (2005) found that firm performance is more volatile in firms with
powerful CEO. Powerful CEOs are likely to be indiscreet in their decision-making because they have more agency conflicts with
shareholders. Han et al. (2016) also showed that powerful CEO firms have poor performance under exogenous shocks. Powerful CEOs
may be overconfident and neglect the advice of other executives, which results in suboptimal decision-making.
However, efficiency theory argues that the CEOs should be more powerful. The benefits of hiring powerful CEOs are greater than
the agency cost (Brickley, Coles, & Jarrell, 1997; Dey et al., 2011). Yang and Zhao (2014) showed that firms have better firm
performance under exogenous shocks when the firms are led by powerful CEOs. Because powerful CEOs have more decision-making
power and lower information asymmetry, they can make speedy decisions in response to exogenous shocks. Dowell et al. (2011) also
found that firms with powerful CEO have stronger survival capabilities when facing financial crises. Powerful CEOs improve orga-
nization efficiency; thus, the probability of financial distress is reduced in a firm. We expect that IT firms with powerful CEOs and a
higher knowledge capital have higher firm values. This expectation is tested by the following hypothesis:
Hypothesis 2:. IT firms have higher Tobin’s Qs when the firms have powerful CEOs and higher knowledge capital.
3. Data source and empirical method
3.1. Data sources
Our data focus on IT firms of US for the period from 2007 to 2014. The data include CEO, firm, and board characteristics that are
collected from Excucomp,Compustat, and IRRC.Excucomp provides the executive information. Compustat provides the company
profiles and financial statements. IRRC provides the corporate governance information. The IT industry is defined by following Fama
and French’s 48 industrial groups, and it includes computers, software, communications, electronic equipment, and the related
services of computer and information.
4
3.2. Measuring knowledge capital
The estimation of the knowledge capital is consistent with the study of Peters and Taylor (2017). Knowledge capital is the
accumulated value of R&D investments. If firms allocate more resources to R&D, they will have greater knowledge capital stocks. The
equation for the knowledge capital stocks is as follows:
= + DG (1 )G R&
Di,t R & i,t 1 i,t
(1)
where G
i,t
and G
i,t−1
are the knowledge capital stocks in the current and previous years, respectively. R&D
i,t
is the R&D expenses in
the current year, and δ
R&D
is the depreciation rate of R&D. We adopt 15% as the depreciation rate according to the guidance that is
4
The SIC codes of the IT industry are 3600, 3620, 3621, 3660, 3695, 3699, 4800, 4899, 3570–3579, 3610–3613, 3623–3629, 3640–3649,
3661–3666, 3669–3679, 3680–3689, 3690–3692, 4810–4813, 4820–4822, 4830–4841, 4880–4892, and 7370–7385.
J. Chiu, et al. North American Journal of Economics and Finance xxx (xxxx) xxxx
3
provided by the United States Bureau of Economic Analysis (BEA).
3.3. Measuring CEO power
The measure of CEO power follows Adams et al. (2005) and includes founder, duality, and insider CEOs. In this study, a powerful
CEO is one who is a founder, duality, or insider. The founder CEO is a founder of the business. Regarding CEO duality, the CEO is also
the chairman of the board of directors. An insider CEO is an inside director.
3.4. Empirical method
Our data are panel data obtained across many firms and years. Petersen (2009) indicated that the standard errors of the ordinary
least squares regression are biased in financial panel data when the residuals are correlated across firms or time. However, this
problem is improved with the Petersen regression. Thus, the Petersen regression is used as the empirical method. The equation is as
follows:
= + + + + + + + +
+ + + + + +
Q KNOW POWER KNOW POWER OWN TENU CEOP SIZE
LEVE CAPX DIVI FAGE Industry dummy Year dummy
i,t i,t 1i,t 2i,t 3i,t i,t 4i,t 5i,t 6i,t 7i,t 8
i,t 9i,t 10 i,t 11 i,t
i
n
t
n
i,t
(2)
where Q
i,t
is Tobin’s Q, KNOW
i,t
is knowledge capital, POWER
i,t
is CEO power, OWN
i,t
is CEO ownership, TENU
i,t
is CEO tenure,
CEOP
i,t
is CEO pay, SIZE
i,t
is firm size, LEVE
i,t
is firm leverage, CAPE
i,t
is capital expenditures, DIVI
i,t
is total dividends, FAGE
i,t
is firm
age, α
i,t
is the constant, and ε
i,t
is the residual. The fixed effects are controlled by industry and year dummies. All variables are defined
in Appendix A.
3.5. Empirical variables
Our empirical variables consist of dependent, independent, omitted, and instrumental variables. The dependent variables are
Tobin’s Q and return on assets. Tobin’s Q is the proxy for firm value, which is defined as the sum of a firm’s market capitalization and
the book value of debt divided by the book value of total assets. The return on assets is a proxy for operating performance and is
measured by the return on total assets before interest and taxes.
The independent variables are CEO and firm characteristics. The CEO characteristics include CEO power, founder CEO, duality
CEO, insider CEO, CEO ownership, CEO tenure, and CEO pay. The firm characteristics include knowledge capital, firm size, leverage,
capital expenditures, cash dividends, and firm age. Those variables are adopted following Adams et al. (2005), Han et al. (2016), Li
(2016), and Peters and Taylor (2017).Dang, Li, and Yang (2018) suggested that the measure of firm size has to fit the empirical
dependent variable. If the measure of firm size is unsuitable, the influence of firm size will not be evident. They thought that the
firms’ net sales could represent the competition of the product market. The competition of the product market may have an important
change due to disruptive innovation. Thus, we adopt firms’ net sales as the measure of firm size.
The omitted variables include CEO pay gap, industry pay, Herfindahl-Hirschman index (HHI), board size, and board in-
dependence. Li (2014, 2016) indicated that CEO pay gap is negatively associated with the balance of CEO power. A small CEO pay
gap in a firm implies that the CEO can be restrained by the second executive. The firm could have better internal governance. Coles,
Li, and Wang (2018) suggested that the CEOs have more incentives to enhance firm performance when their respective compensation
is high. Giroud and Mueller (2011) also suggested that the benefits of better corporate governance are weak in the highly competitive
industry because the CEOs cannot be ineffective. Thus, these variables are adopted following those studies.
Finally, we use CEO age and female CEO as instrumental variables. CEO age and gender could affect the financial outcome in a
firm through corporate decision-making. Serfling (2014) showed that older CEO firms have lower R&D expenses and lower operating
leverage. Croci, Giudice, and Jankensgard (2017) also showed that older CEOs have a greater motivation to enforce hedging stra-
tegies using familiar tools. Older CEOs have a higher risk aversion and favor a quiet life; therefore, they prefer low risk decisions.
Furthermore, Huang and Kisgen (2013) and Faccio, Marchica, and Mura (2016) found that female CEO firms have lower leverage,
reduced earnings volatility, and less mergers and acquisitions. Female CEOs are less overconfident and more careful and discreet in
their decision-making. They also have lower motivations to make risky decisions.
4. Empirical results
4.1. Descriptive statistics
Table 1 reports descriptive statistics. Our data cover the period from 2007 to 2014. We find that most IT firms are led by powerful
CEOs. The mean of CEO power is 0.78. Most firms are led by insider CEOs followed by duality CEOs and founder CEOs. The mean of
CEO pay and gap are 8.14 and 0.43, respectively. In terms of firm characteristics, the mean of firm value and performance are 2.11
and 0.09, respectively. The average ratio of knowledge capital to total assets is 0.19. The mean of firm size is 6.78. Further, the mean
board size and independence are 8.61 and 0.78, respectively.
The correlation matrix is provided in Table 2. The results show that CEO power is not significantly associated with firm value,
J. Chiu, et al. North American Journal of Economics and Finance xxx (xxxx) xxxx
4
operating performance, and knowledge capital. Firms have high value and poor performance when they have a higher knowledge
capital. Knowledge capital has a deferred characteristic, so its benefits are revealed over the long-term (Eberhart et al., 2004).
Furthermore, firms have higher value, poorer performance, and higher knowledge capital when their CEOs are a founder. Founder
CEOs have lower agency conflicts with shareholders and are more focused on long-term benefits. They may forgo short-term benefits
(Fahlenbrach, 2009; Gao & Jain, 2011). Duality CEOs are not significantly related to firm value, operating performance, and
knowledge capital. Insider CEOs are significantly associated with knowledge capital. In addition, CEO pay gap is negatively asso-
ciated with firm value. A large CEO pay gap implies that the CEO may not be restrained by a second executive. The CEO may have
more agency conflicts with shareholders (Li, 2016).
4.2. The effects of knowledge capital and CEO power on firm value
Table 3 reports the effects of knowledge capital and CEO power on firm value. Our results show that IT firms with a higher
knowledge capital have higher values because firms have better innovation originality and product efficiency to make differentiated
products (Chan et al., 2001; Eberhart et al., 2004; Gu, 2016; Hombert & Matray, 2018; Peters et al., 2017). Thus, for IT firms,
knowledge capital is an important asset and is associated with competitive advantages. The results are consistent with hypothesis 1.
The results also prove that powerful CEOs cannot enhance firm value. This finding may be attributed to the fact that the benefits of
hiring powerful CEOs are neutralized by the agency costs; therefore, powerful CEOs have a positive insignificant effect on firm value.
In addition, we also find that powerful CEO firms with a higher knowledge capital have higher firm values. This finding could be
attributed to the fact that the benefits of holding intensive knowledge capital are higher than the agency costs of hiring powerful
CEOs. Although powerful CEOs are likely to cause higher agency costs, they may create more benefits for firms by improving the
efficiency of organization and resources utilization. Our findings suggest that powerful CEOs enhance the utilization efficiency of
knowledge capital given their greater influence and decision-making power (Dey et al., 2011; Dowell et al., 2011; Fahlenbrach, 2009;
Gao & Jain, 2011; Yang & Zhao, 2014). Thus, IT firms have higher firm values and better competitive advantages when the firms have
powerful CEOs and higher knowledge capital. The results are consistent with hypothesis 2.
4.3. The effects of knowledge capital and the different types of CEO power on firm value
Table 4 reports the interactive effects between knowledge capital and the different types of CEO power (founder CEOs, duality
CEOs, and insider CEOs) on firm value. Our results show that founder and duality CEO firms with a higher knowledge capital have
higher values. Founder CEOs have fewer agency conflicts with shareholders and focus on long-run performance. They also have more
incentives to enhance the efficiency of organization and resources utilization. Thus, firms have higher values when the CEOs are a
Table 1
Descriptive statistics.
Mean STD. Min. Q1 Med. Q3 Max. N
Firm characteristics:
Q 2.11 1.40 0.56 1.25 1.66 2.48 15.81 1260
ROA 0.09 0.09 −0.52 0.04 0.08 0.13 0.55 1260
KNOW 0.19 0.21 0.00 0.00 0.13 0.30 0.91 1260
SIZE 6.78 1.67 2.72 5.60 6.46 7.90 11.79 1260
LEVE 0.14 0.18 0.00 0.00 0.05 0.22 0.69 1260
CAPX 0.04 0.04 0.00 0.01 0.03 0.05 0.32 1260
DIVI 0.01 0.04 0.00 0.00 0.00 0.01 0.38 1260
HHI 0.22 0.20 0.05 0.08 0.14 0.26 1.00 1260
FAGE 22.60 16.94 6.00 12.00 17.00 26.00 90.00 1260
CEO characteristics:
POWER 0.78 0.42 0.00 1.00 1.00 1.00 1.00 1260
FOUNDER 0.30 0.46 0.00 0.00 0.00 1.00 1.00 1260
DUALITY 0.44 0.50 0.00 0.00 0.00 1.00 1.00 1260
INSIDER 0.56 0.50 0.00 0.00 1.00 1.00 1.00 1260
OWN 0.03 0.08 0.00 0.00 0.00 0.02 0.54 1260
TENU 7.79 6.97 0.00 3.00 6.00 11.00 38.00 1260
CEOP 8.14 1.04 5.54 7.40 8.09 8.80 11.96 1260
CEOG 0.43 0.22 0.00 0.28 0.45 0.60 0.96 1260
INDP 12.33 1.40 6.06 11.46 12.46 13.48 13.99 1260
Board characteristics:
BSIZE 8.61 2.21 4.00 7.00 8.00 9.00 18.00 816
BIND 0.78 0.11 0.36 0.71 0.80 0.88 1.00 816
This table provides descriptive statistics. The data cover the interval between 2017 and 2014. Q is Tobin's Q, ROA is the return on assets, KNOW is
knowledge capital, SIZE is firm size, LEVE is firm leverage, CAPX is capital expenditure, DIVI is cash dividends, HHI is Herfindahl–Hirschman index,
FAGE is firm age, POWER is CEO power, FOUNDER is a founder CEO, DUALITY is CEO duality, INSIDER is an insider CEO, OWN is CEO ownership,
TENU is CEO tenure, CEOP is CEO pay, CEOG is CEO pay gap, INDP is industry pay, BSIZE is board size, and BIND is board independent.
J. Chiu, et al. North American Journal of Economics and Finance xxx (xxxx) xxxx
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