A new peer-reviewed study published in Thunderbird International Business Review is challenging a long held assumption in corporate finance and innovation economics: that profitability and heavy research investment automatically increase a company’s market value. The research, titled “When Profitability Speaks Loudest: How Institutional Quality Shapes Valuation in Global Semiconductor Firms”, was led by Tsuyoshi Sato of Tokyo Star Bank, Ltd and Kokugakuin University Tochigi Junior College in Japan. It provides fresh empirical evidence that the real driver of valuation in the global semiconductor industry is not just financial performance but the institutional environment in which firms operate.
Drawing on data from 57 multinational semiconductor firms across 21 countries between 2005 and 2023, the study demonstrates that profitability, innovation spending, and capital structure are filtered through governance quality.
Why valuation in the semiconductor industry is different
The semiconductor sector sits at the centre of the digital economy. It underpins artificial intelligence, telecommunications, medical imaging and renewable energy technologies. At the same time, it is one of the most capital intensive and research intensive industries in the world. Fabrication plants require billions in upfront investment, while product development cycles can span several years.
Traditional financial theory assumes that firms with strong profitability and high innovation investment should enjoy superior market valuation. However, the semiconductor industry complicates this logic. Long development timelines, heavy exposure to geopolitical risk and dependence on intellectual property protection create uncertainty that investors must factor into pricing decisions.
According to Sato’s analysis, valuation is not determined by firm performance alone. Instead, it reflects a complex interaction between company-level indicators such as return on assets and research intensity, and national-level governance conditions such as legal enforcement and regulatory quality.
The research design behind the findings
The study used a panel dataset of 881 firm-year observations from publicly listed semiconductor companies operating across Asia, Europe and North America. Financial indicators, including profitability, leverage, and research expenditure, were combined with institutional indicators from the World Bank Worldwide Governance Indicators database.
Firm valuation was measured using the price-to-book ratio, a widely accepted market-based indicator that reflects investors’ expectations of future growth and intangible assets. Fixed-effects regression models were used to control for firm-specific characteristics and long-term structural differences across companies.
By introducing interaction terms between firm performance and institutional variables, the study examined how governance quality modifies the impact of profitability and innovation on valuation. This approach allowed the researcher to isolate the moderating role of institutions rather than treating them as background conditions.
Profitability only pays off under strong rule of law
One of the most striking results of the study is that return on assets is not universally rewarded by financial markets. Across the full sample, higher profitability was associated with a lower price to book ratio. This counterintuitive finding reflects the maturity dynamics of the semiconductor sector, where highly profitable firms are sometimes perceived as having limited growth potential.
However, when profitability was examined in combination with rule of law indicators, a different pattern emerged. In countries with strong legal enforcement and reliable contract protection, profitability translated into higher market valuation. Investors appeared more willing to trust reported earnings when institutional credibility was high.
This finding supports institutional theory, which argues that financial signals are only meaningful when supported by strong governance frameworks. In weaker institutional environments, concerns about earnings manipulation, opaque reporting and enforcement gaps reduce investor confidence. As a result, profitability alone does not guarantee valuation premiums.
When innovation spending becomes a liability
Research and development investment is widely regarded as a core driver of competitive advantage in technology industries. Semiconductor firms routinely allocate large portions of revenue to chip design, materials science and process innovation. Yet the study reveals that innovation spending does not always boost firm valuation.
In highly regulated environments, the interaction between research intensity and regulatory quality produced a strong negative effect on valuation. Investors appeared to discount companies that increased research spending under strict regulatory regimes .
Several mechanisms may explain this outcome. Export controls, technology transfer restrictions and complex compliance requirements can delay commercialisation of new products. Regulatory approval processes may slow deployment of manufacturing capacity. Administrative burdens can divert managerial attention and financial resources away from innovation execution.
Rather than interpreting research investment as a signal of future growth, investors may view it as a source of uncertainty when regulatory systems are heavy or unpredictable. This challenges the assumption that innovation expenditure is universally rewarded by capital markets.
One key message of my research is that financial performance does not speak for itself. Investors interpret profitability and innovation spending through the lens of national institutions, such as the rule of law and regulatory quality. Without credible governance, even strong financial results may fail to translate into higher firm valuation.
-Tsuyoshi Sato
Political stability changes how debt is perceived
Capital structure also plays a critical role in valuation outcomes. Semiconductor firms frequently rely on debt financing to fund large scale infrastructure projects. The study found that leverage was more positively valued in countries with high political stability.
This suggests that investors tolerate higher debt levels when macro political risk is low. Stable political environments reduce uncertainty about tax policy, industrial regulation and government intervention. As a result, debt is seen as a manageable financing tool rather than a financial vulnerability .
In politically unstable contexts, however, leverage may amplify perceived risk. Sudden policy changes, trade restrictions or geopolitical tensions can disrupt cash flows and increase refinancing costs. This dynamic reinforces the importance of aligning financial strategy with national governance conditions.
Implications for corporate strategy and investor relations
The findings carry important implications for corporate executives and investor relations professionals operating in the semiconductor industry. Financial performance alone is not sufficient to secure valuation premiums. Firms must actively manage how performance signals are communicated within specific institutional contexts.
In countries with strong rule of law, profitability metrics such as return on assets can be emphasised as credible indicators of operational efficiency. In weaker governance environments, firms may need to supplement financial disclosures with enhanced transparency, third party audits and governance reforms to build investor trust.
Innovation strategy also requires institutional awareness. In highly regulated markets, companies may benefit from clearly outlining commercialisation timelines, regulatory compliance strategies and expected returns on research projects. Without this context, large research budgets risk being interpreted as inefficient spending.
Capital structure decisions should similarly reflect political conditions. Conservative debt strategies may be more appropriate in volatile environments, while stable jurisdictions offer greater flexibility for leveraged investment.
A changing landscape for global technology investment
The semiconductor industry is currently undergoing rapid transformation. Governments are investing heavily in domestic chip manufacturing capacity. Trade tensions are reshaping supply chains. Artificial intelligence and advanced computing are accelerating demand for high performance processors.
Against this backdrop, Sato’s research provides a reminder that technological leadership is not driven by engineering excellence alone. Institutional quality shapes how innovation is financed, valued and scaled globally.
As competition intensifies, countries that combine technological capability with strong governance frameworks may gain a structural advantage. For firms operating across borders, understanding institutional differences is becoming as important as mastering production efficiency.
Reference
Sato, T. (2025). When profitability speaks loudest: How institutional quality shapes valuation in global semiconductor firms. Thunderbird International Business Review. https://doi.org/10.1002/tie.70034
