How Does Firm Digitalization Affect Innovation Risk? —Empirical Research from Chinese Manufacturing Firms

Abstract

In the era of digitalization, firms face an increasingly complex external environment, accompanied by a constant rise in the cost of innovation projects. Consequently, the risk associated with firm innovation is on the ascent. This paper empirically investigates the impact and heterogeneity of firm digitalization on innovation risk, focusing on process reshaping and organization reengineering. Utilizing an unbalanced panel structure comprising data from 2,124 unique manufacturing firms spanning the years 2011 to 2020, with 13,546 firm-year observations, our analysis reveals the following findings:

Firm digitalization exhibits a discernible U-shaped influence on innovation risk. Specifically, when firm digitalization falls below the inflection point, it mitigates innovation risk; conversely, when firm digitalization surpasses this inflection point, it amplifies innovation risk. This suggests that excessive digitization may escalate innovation risk by necessitating costly adjustments due to routine updates. This conclusion withstands various robustness tests, including the instrumental variable method, alternative measurement indicators, and model adjustments.

Heterogeneity analysis demonstrates that the U-shaped influence of firm digitalization on innovation risk is more pronounced in non-state-owned, small and medium-sized, central and western firms, and firms with a low degree of marketization. This phenomenon is closely linked to firms’ inability to accommodate the cost adjustments required by practice updates, owing to limited internal resources and external support. Mechanism analysis indicates that firm digitization’s nonlinear U-shaped effect on innovation risk is driven by the combined action of two mechanisms: the expense rate during the sales period and the operating cost rate.

The research findings of this paper offer valuable insights for accurately assessing the innovation impact of real firm digitalization, while furnishing empirical evidence to advance the integration of the real economy with the digital economy. Presently, firm digitalization remains in an exploratory phase characterized by high uncertainty. Beyond investing in hardware and software systems, firms must prioritize addressing coordination and governance challenges in digitalization. Neglecting aspects such as manpower training and supportive investments can lead to increased costs. Thus, firms must recognize that digitization is a gradual process and not an overnight endeavor. Moreover, the government should align with the digital economy’s development trajectory by incentivizing firms to pursue digitalization and creating an enabling environment for their endeavors. Additionally, tailored and differentiated digitalization-related policies should be implemented based on firms’ micro-attributes and external environment.

This study contributes in two main ways. Firstly, it enriches and broadens the research framework surrounding firm digitalization and its economic implications. Unlike previous literature, this paper evaluates the role of micro-level firm digitalization in fostering firm innovation by examining innovation risk, thus complementing existing research on digitalization and firm innovation. Secondly, by exploring the impact of enterprise digitalization on innovation risk through R&D process remodeling and R&D organization restructuring, the study elucidates the mechanism underlying cost uncertainty at a theoretical level.