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Tech stocks in Berlin before 1913

In “The Berlin Stock Exchange in Imperial Germany - a Market for New Technology?”, (pdf) Sibylle Lehmann-Hasemeyer and Jochen Streb look at how well the financial market assessed firm innovativeness in pre-1913 Germany. They show that the stock market guessed well which companies would continue to innovate after they went public.

Between 1892 and 1919, 474 companies started trading their shares on the Berlin stock exchange. The authors take the change in the price of the stock on its first day of trading as an measure of “underpricing” which indicates how much asymmetric information there is in the markets.

Underpricing is bad for a firm, as it receives fewer funds than if it had sold its shares at a higher price. For example, Google went to great lengths to determine a good price. And with more capital the firm can invest more into research and so be granted more patents later. So one has to argue that this effect can’t be strong enough to lead to reverse causality.

Lehmann-Hasemeyer and Streb control for what investors knew at the time of the initial public offering (IPO) about how innovative firms already were. For this, they count the number of patents a firm had been granted before. So patents are a proxies for the innovativeness of a firm. This is an example of using patents as “inputs” to the technological process, in Zvi Griliches’ wording.

Research is a risky activity, so there might be more asymmetric information in the price for stocks of research-intensive companies. But that’s not what they find as there was little underpricing in the stocks of firms that continued to be innovative after the IPO. This might be due to the screening of banks:

Overall, German universal banks seemed to be well informed about the market value of firms that planned to go public. The comparatively low underpricing that occurred at the Berlin stock exchange during Germany’s high industrialization might therefore indicate that investors’ uncertainty was rather small because they knew that banks brought only those firms to the market that met certain minimum quality requirements.

They conclude that investors must have had more information than patent counts:

[Investors] were capable of distinguishing between permanently innovative firms and firms with sharply declining innovativeness (Buddenbrooks), even though both types of firms looked very similar at the date of the IPO with respect to their patent history. This observation implies that pure patent counts that are often used in cliometric studies of innovation might not be a good proxy for the knowledge that was available at the date of an IPO.

The paper is forthcoming in the American Economic Review.