What rates of return do firms expect from innovation investments?

Abstract Innovation investments are risky and uncertain in their outcomes. Thus, innovating firms should expect higher rates of return if their investments are successful to compensate for the additional risk and uncertainty. Further, financiers also have different appetites for risk and uncertainty thus they will only fund projects that fit their risk-return profile. In this paper we use a large UK firm investment and finance decision making survey to establish what rates of return firms expect from their innovation investments and whether this differs across different types of investment financiers. Our core results show that process and product/service innovation investments have an expected return of 15 to 20% and IT investments an expected return of 10 to 15%. This implies that IT investments are perceived to be less risky than other innovation investments, therefore with relatively lower expected returns. From our econometric analysis, it is also the case that firms that finance innovation investments with retained cash have lower expected returns whilst firms attracting external equity have the highest expected returns. Our findings add to our understanding of what firms expect when they invest in innovation and how this is shaped by the type of finance they use.