Finance Research Letters 51 (2023) 103457

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Finance Research Letters

journal homepage: www.elsevier.com/locate/frl

Breaking barriers to innovation: The power of

digital transformation
Yuhao Niu , Wen Wen *, Sai Wang , Sifei Li
International Business School, Beijing Foreign Studies University

A R T I C L E I N F O A B S T R A C T

JEL classification: This study analyzes the impact of digital transformation on corporate innovation. Based on a
G30 sample of Chinese listed companies during 2007-2019, we find that digital transformation has a
O31 positive impact on corporate innovation. Mechanism tests show that digital transformation helps
Keywords: alleviate corporate financial constraints and improve corporate governance, thus breaks barriers
Digital transformation to corporate innovation. Heterogeneity analysis reveals that the positive impact of digital
Corporate innovation
transformation on corporate innovation is more pronounced in high-tech industries and in in­
Financial constraints
dustries with more intense competition. These findings enrich the growing literature on the
Corporate governance
Industry heterogeneity economic consequences of digital transformation and have policy implications for promoting
corporate innovation.

1. Introduction

The development of digital technologies triggers digital transformation, as a strategic priority, which assures enterprises catch up
with industry forefront in the turbulent, spurring managers to accelerate digital transformation for long-term growth. Vial (2019)
defines digital transformation as a process wherein firms respond to changes emerging in their environment by using digital tech­
nologies to yield new paths of value creation. In recent years, firms in almost all industries take an active part in digital transformation
to accomplish their visions in the competitive context (Matt et al., 2015). Therefore, exploring the resultant effects of digital trans­
formation from micro enterprises’ point of view contributes to developing the digital economy and to promoting the integration of the
digital and real economies.
Extant literature points out that digital transformation results in anabatic industrial competition momentum and ever-changing
consumer behaviors (Verhoef et al., 2019), improves corporate risk-taking ability (Tian et al., 2022), resource management and
process efficiency (Pagani and Pardo, 2017), and information environment (Chen et al., 2022; Wu et al., 2022). However, to the best of
our knowledge, the effect of digital transformation on corporate innovation has not been fully explored.
Innovation is a crucial driving force of attaining and sustaining competitiveness and performance for firms. It is also an imperative
of promoting sustainable economic growth for nations, especially for emerging counties like China. However, firms engaging in
innovative activities might be at a deadlock. Distinguished from their counterparts, innovative activities are characterized by long
payback period, costly, risky, challenging and high-uncertainty in nature (He and Tian, 2018). Additionally, successful innovation is
difficult for most of firms owning to innovation barriers range from intrafirm to market (Szambelan et al., 2019). Therefore, studying

* Corresponding author at: International Business School, Beijing Foreign Studies University, No.19 North Xisanhuan Road, Haidian District,
Beijing, P.R. China.
E-mail address: [email protected] (W. Wen).

https://doi.org/10.1016/j.frl.2022.103457
Received 23 July 2022; Received in revised form 22 October 2022; Accepted 1 November 2022
Available online 6 November 2022
1544-6123/© 2022 Elsevier Inc. All rights reserved.
Y. Niu et al. Finance Research Letters 51 (2023) 103457

on the determinants of corporate innovation has attracted much attention from academia.
A great many of scholars have explored a wide range of determinants of innovation over the past few decades (He and Tian, 2018).
At the firm-level, existing literatures find that corporate governance quality (O’Connor and Rafferty, 2012), analyst coverage (He and
Tian, 2013), and financing constraints (Kelley, 2009) impact corporate innovation. As for the industry-level, prior studies present that
market competition (Aghion et al., 2005) affects innovation. In recent years, the Chinese government proposed and vigorously pro­
moted the digital-driven development strategy (Wu et al., 2022). Therefore, does digital transformation influence corporate inno­
vation? If so, through which channels does digital transformation affect corporate innovation? There is little literature to investigate
this issue, and our paper aims to fill this void.
We conjecture that digital transformation can enhance corporate innovation. Firstly, digital transformation generates resource
superiority. Shortage of resource hampers corporate innovation (Kelley, 2009). Elliott (2011) points out that complex information
environment imposes barriers to investor’s understanding of business, and damages investors’ trust on firms. Digital transformation
enables companies to improve resource management efficiency (Pagani and Pardo, 2017), accelerates the integration of information
and improves information transparency (Chen et al., 2022). Therefore, digital transformation decreases the information process cost of
investors and helps companies easily access to finance. In addition, corporate digital transformation is highly consistent with the
digital-driven development strategy in China. Firms positively engaging in digital transformation are easier access to government
resources and enjoy preferential policies such as tax incentives and credit preferences. Therefore, digital transformation can alleviate
firms’ financial constraints and promote corporate innovation. Secondly, digital transformation brings about governance effect. The
agency problem and management’s reluctance to take risks hinder corporate innovation (O’Connor and Rafferty, 2012). Digital
transformation is conducive to optimize logistic streams and transparentize business process (Verhoef et al., 2019), and to improve
information dissemination efficiency and corporate information environment (Chen et al., 2022). Thus, digital transformation can
decrease information asymmetry between managers and shareholders and mitigate management myopia, further improving inno­
vation willingness of managers. Above all, we propose that digital transformation potentially breaks barriers of innovation and
markedly promotes corporate innovation.
To certify the foregoing assumption, this paper investigates the impact of digital transformation on corporate innovation based on
Chinese listed companies’ data during the period of 2007 to 2019. We contend that the Chinese market provides an ideal setting to
study digital transformation. Driven by a series of government’s supportive policies about digitalization, the scale of China’s digital
economy has grown from 11 trillion RMB in 2012 to about 45 trillion RMB in 2021. The proportion of digital economy in GDP also
increases from 21.6% to 39.8%, according to the Ministry of Industry and Information Technology of the People’s Republic of China.
The empirical evidence of the influence of digital transformation on the Chinese market can provide insights for other emerging
economies.
We construct a measure of corporate digital transformation using textual analysis1. The baseline results reveal that digital trans­
formation has a positive effect on corporate innovation. Channel tests reveal that digital transformation helps companies alleviate
financial constraints and improve corporate governance, thus improves corporate innovation. Cross-sectional results show that both
high-tech industries and market competition strengthen the positive impact of digital transformation on corporate innovation.
The marginal contributions of this paper are as follows. First, this study extends a long and large literature on the determinants of
corporate innovation. Prior research investigates the determinants of corporate innovation from perspectives of industry competition
(Aghion et al., 2005) and firm characteristics (O’Connor and Rafferty, 2012; He and Tian, 2013; Kelley, 2009). However, little
attention has been paid to the impact of digital transformation, a key strategy for economic development, on corporate innovation.
This paper expands the empirical study on the determinants of corporate innovation based on digital transformation. Second, our
findings contribute to a growing body of literature that studies the economic consequences of digital transformation. Previous liter­
atures show that the impact of digital transformation on industrial competition and consumer behaviors (Verhoef et al., 2019),
corporate risk-taking ability (Tian et al., 2022), stock price crash risk (Wu et al., 2022), and firm value (Dubey et al., 2019). Our
research extends the literature on digital transformation by providing evidence that digital transformation affects corporate inno­
vation. In addition, corporate innovation is particularly of great significance for emerging economies, such as China. This paper
substantiates the positive effect of digital transformation on corporate innovation, providing important theoretical basis and references
for the government to implement digital economy strategies and innovation policies.

2. Research design

2.1. Samples and data

Our sample initially consists of listed firms on the Shanghai Stock Exchange (SHSE) and Shenzhen Stock Exchange (SZSE) during

1
In detail, we use Python software to obtain annual reports of all Chinese A-share listed companies, and use Java PDFbox to extract all text
contents of annual reports. We follow prior literature (Wu et al., 2021; Wu et al., 2022) to construct the digital transformation related dictionary. On
this basis, we exclude the negative words such as “no”, “none”, “not”, etc. in front of the keywords, and also exclude the words that are not related to
the company itself. Finally, based on the dataset extracted from the annual reports text of listed companies by Python, the keywords relevant to
digital technology are categorized into five genres, including Artificial Intelligence, Chain Blocks, Cloud Computing, Big Data, and Digital Tech­
nology Application, and the frequency of them is added respectively to form the final keyword frequency, as the measure of the digital trans­
formation index.

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Y. Niu et al. Finance Research Letters 51 (2023) 103457

the period of 2007–2019. Considering the potential reverse causality between digital transformation and corporate innovation, we
forward dependent variables for one period. We exclude financial firms and observations with missing variables. Applying the above
criteria yielded a final sample of 15,259 firm-year observations.

2.2. Variables

2.2.1. Independent variable: digitalization

Following prior literature (Wu et al., 2021; Wu et al.,2022), we calculate the frequency of occurrence of the
digital-transformation-related keywords in the annual reports of listed companies as the proxy for the degree of corporate digital
transformation (DCG). The keywords include a dictionary of artificial intelligence, blockchain, cloud computing, big data and digital
technology application. To mitigate the right-biased problem, we take the natural logarithm of firm i’s digital transformation keywords
plus one in year t.

2.2.2. Dependent variable: innovation

Following prior studies (Yuan and Wen, 2018), we employ two measures of innovation, which are both patent-based metrics. The
first measure, Patent_i, is the natural logarithm of one plus firm i’s invention patents application in year t+1. The second, Patent_t, is the
natural logarithm of one plus firm i’s all patents application in year t+1, including invention patents, design patents, and utility model
patents.

2.3. Empirical models

We construct Model (1) to examine the relationship between enterprise digitization and corporate innovation.
/
Patent t Patent ii,t+1 = β0 + β1 DCGit + βi Controlsit + YEAR + IND + εit (1)

where i indexes firm, t indexes time. The dependent variable, Innovation, represents firms’ innovation output. The independent var­
iable, DCG, is the measure of the level of corporate digital transformation. The vector Controls represent a series of firm characteristics
that has been shown to affect corporate innovation. Moreover, we add industry and year dummies. To mitigate the undue influence of
extreme values, we winsorize all continuous variables by 1% in both tails.

2.4. Descriptive statistics

Table 2 presents the descriptive statistics. The results show that the mean values of Patent_total and Patent_invention are 1.999 and
1.424, respectively. The mean and standard deviation of digitization (DCG) are 1.765 and 1.342, respectively, which indicates that
digital transformation differs in different firms. All sample distributions of control variables are consistent with extant research.

3. Empirical results

3.1. Digital transformation and innovation

Table 3 presents the regression results of model (1). The dependent variable is Patent_t in columns (1) and (2), and Patent_i in
columns (3) and (4). The coefficients on DCG are all positive and significant, indicating that the level of digital transformation is
positively associated with corporate patent applications and innovation outputs. Therefore, the baseline regression results imply that
an increase on digital transformation of firms increases corporate innovation.

Table 1
Definitions of the main variables.
Variables Definitions

Patent_t The natural logarithm of one plus firm i’s total patents, including invention patents, design patents, and utility model patents
Patent_i The natural logarithm of one plus firm i’s invention patents application.
DCG The frequency of occurrence of the corresponding digital transformation keywords in the annual reports of listed companies
Size The natural logarithm of total assets
ROA Net income divided by total assets
Lev The book value of total liabilities divided by total assets
Cash Cash and cash equivalent divided by total assets
Growth The increased percentage of sales revenue
CFO Operating cash flow divided by the book value of total asset
Top1 The percentage of shares owned by the largest shareholder
State An indicator variable that equals 1 if the firm is an state-owned entity, and 0 otherwise.
Age The difference between year t minus the year when a firm was established
Dual An indicator variable that equals 1 if the chairman concurrently serves as the CEO, and 0 otherwise.
Rind The number of independent directors divided by the total number of board directors

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Table 2
Descriptive Statistics of the main variables. This table reports descriptive statistics of our main variables. Detailed definitions of variables are pre­
sented in Table 1. All continuous variables are winsorized at 1% at both tails.
Variables N Mean SD Q1 Median Q3

Patent_t 15,259 1.999 1.906 0.000 1.792 3.401

Patent_i 15,259 1.424 1.612 0.000 1.099 2.485
DCG 15,259 1.765 1.342 0.693 1.609 2.708
Size 15,259 22.209 1.465 21.223 22.076 23.099
ROA 15,259 0.029 0.069 0.009 0.029 0.057
Lev 15,259 0.521 0.230 0.358 0.517 0.664
Cash 15,259 0.158 0.113 0.078 0.131 0.208
Growth 15,259 0.209 0.689 -0.040 0.099 0.262
CFO 15,259 0.045 0.078 0.003 0.044 0.090
Top1 15,259 0.357 0.156 0.233 0.334 0.471
State 15,259 0.612 0.487 0.000 1.000 1.000
Age 15,259 17.033 5.425 13.000 17.000 21.000
Dual 15,259 0.157 0.364 0.000 0.000 0.000
Rind 15,259 0.368 0.054 0.333 0.333 0.400

3.2. Robustness tests

3.2.1. Firm-fixed effects model

To mitigate potential problems caused by omitting time-invariant firm-specific characteristics, we re-estimate the regressions of
model (1) using the firm-fixed effects model. The results shown in the first two columns of Table 4 suggest that the estimated co­
efficients on the variable DCG are significantly positive at the 1% level, implying that our results are not driven by time-invariant firm-
specific characteristics.

3.2.2. Instrumental variable estimations

We further alleviate the endogeneity based on the instrumental variable method. Following previous literature (Kong et al., 2021;
Wu et al., 2022), we calculate the year-industry and year-province average of digital (AverageI, AverageP) as instrument variables and
conduct two-stage least squares (2SLS) test. Table 4 presents the results for the 2SLS regression. The results shown in column (3) and

Table 3
Regression of digital transformation on corporate innovation. The t-statistics are presented in the parenthesis and superscripts ***, **, *, and denote
statistical significance at the 1%, 5% and 10% levels, respectively. The following tables are the same.
Variables Patent_t Patent_i
(1) (2) (3) (4)

DCG 0.437*** 0.255*** 0.373*** 0.218***

(16.49) (11.59) (15.45) (10.88)
SIZE 0.543*** 0.460***
(23.50) (20.75)
ROA 1.836*** 1.295***
(6.88) (5.86)
LEV -0.117 -0.069
(-1.12) (-0.80)
CASH 0.479** 0.500***
(2.44) (2.76)
GROWTH -0.055*** -0.034**
(-3.11) (-2.30)
CFO -0.005 0.055
(-0.02) (0.28)
TOP1 -0.292 -0.339**
(-1.58) (-2.03)
STATE 0.052 0.093*
(0.91) (1.82)
AGE -0.011 -0.010
(-1.68) (-1.68)
DUAL 0.001 0.014
(0.03) (0.30)
RIND 0.795* 1.038***
(1.93) (2.75)
CONSTANT 0.215 -11.134*** 0.055 -9.710***
(1.21) (-21.69) (0.40) (-19.79)
YEAR&IND Yes Yes Yes Yes
OBS 15,259 15,259 15,259 15,259
ADJ-R2 0.360 0.506 0.327 0.474

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(4) of Table 4 suggest that the results are robust after addressing the endogenous issues.

3.2.3. Forwarding two period dependent variables

Since the innovation process generally takes longer than one year, we forward two period dependent variables. The results shown
in the last two columns of Table 4 suggest that the coefficients on DCG are positive and significant, indicating that digital trans­
formation can promote corporate innovation in a long time series.

4. Possible mechanisms

4.1. Mitigating financial constraints

We first test whether digital transformation promotes corporate innovation through alleviating financial constraints. Corporate
digital transformation is highly consistent with the digital-driven development strategy in China and firms positively engaging in
digital transformation are easier access to bank loans and enjoy preferential policies. Hence, we predict that alleviating financial
constraints can be one possible mechanism that digital transformation promotes corporate innovation.
Following prior literature (Kaplan and Zingales, 1997), we use KZ index to proxy for financial constraints, and a larger value of KZ
index suggests that firms are faced with severer financial constraints. Following Tian et al. (2022), we examine the mediation effect by
testing the interaction role of digital transformation and financial constraints. We generate a dummy variable, H_KC, which equals one
if the KZ index is above the industry-year median value, and otherwise zero. We interact digital transformation (DCG) and financial
constraints (H_KZ), and add the interaction term (DCG × H_KZ) and H_KZ into model (1). The estimation results are shown in columns
(1) to (2) in Table 5. The coefficients on DCG × H_KZ are positive and significant at the 1% level, suggesting that the impact of digital
transformation on corporate innovation is more pronounced in firms with severe financial constraints. The results indicate that digital
transformation promotes corporate innovation by reducing financial constraints.

4.2. Improving corporate governance

We then conduct the mechanism test from the perspective of corporate governance. Digital transformation plays the role of
corporate governance, and is conducive to optimizing logistic streams, transparentizing business process, and improving internal
control quality. Hence, if our hypothesis holds, digital transformation will increase corporate governance level by improving internal
control quality.
Following previous literature (Wang et al., 2018), we use the internal control index obtained from DIB database to represent in­
ternal control quality. A high value of IC proxies for better internal control quality. We generate a dummy variable, L_IC, which equals
one if the internal control index is lower than the industry-year median value, and otherwise zero. We interact digital transformation
(DCG) and internal control quality (L_IC), and add the interaction term (DCG × L_IC) and L_IC into model (1). The empirical results are
shown in columns (3) to (4) in Table 5. The coefficients on DCG × L_IC are positive and significant at the 1% level, suggesting that the
impact of digital transformation on corporate innovation is more pronounced in firms with weaker internal control quality. The results
present that digital transformation promotes corporate innovation by improving internal control quality, namely improving corporate
governance.

5. Heterogeneity analysis

5.1. The effect of high-tech industry

High-tech enterprises have advanced technical resources required by digital transformation, which can effectively and agilely
embed into their own organizational structure and decision-making system. Therefore, we predict that the influence of digital

Table 4
Robustness checks of endogeneity.
Variables Firm-fixed effects model Two-stage least-squares regressions Lagging two period independent variable
Patent_t Patent_i Patent_t Patent_i Patent_t Patent_i
(1) (2) (3) (4) (5) (6)

DCG 0.043*** 0.051*** 1.041*** 0.942*** 0.248*** 0.218***

(4.07) (5.68) (7.54) (8.24) (10.65) (10.19)
CONTROLS Yes Yes Yes Yes Yes Yes
CONSTANT -5.886*** -5.149*** -7.846*** -6.686*** -11.684*** -10.150***
(-19.43) (-19.77) (-10.03) (-9.69) (-20.07) (-18.11)
FIRM Yes Yes No No No No
IND No No Yes Yes Yes Yes
YEAR Yes Yes Yes Yes Yes Yes
OBS 15,259 15,259 15,259 15,259 13,416 13,416
ADJ-R2 0.258 0.252 0.339 0.277 0.498 0.467

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Table 5
Possible mechanism analysis.
Variables Patent_t Patent_i Patent_t Patent_i

DCG 0.197*** 0.177*** 0.214*** 0.197***

(7.87) (7.67) (8.44) (8.18)
DCG × H_FC 0.103*** 0.072***
(4.31) (3.28)
H_FC -0.141*** -0.078*
(-2.65) (-1.75)
DCG × L_IC 0.085*** 0.055**
(3.76) (2.55)
L_IC -0.142*** -0.019
(-2.82) (-0.45)
CONTROLS Yes Yes Yes Yes
CONSTANT -11.012*** -9.636*** -11.000*** -9.796***
(-21.33) (-19.54) (-21.30) (-19.78)
YEAR & IND Yes Yes Yes Yes
OBS 15,259 15,259 15,259 15,259
ADJ-R2 0.507 0.475 0.506 0.474

Table 6
The moderating effect of high-tech industry and industry competition.
Variables Patent_t Patent_i Patent_t Patent_i

DCG 0.172*** 0.120*** 0.163*** 0.123***

(6.01) (4.92) (6.24) (5.57)
DCG × H_Tech 0.141*** 0.179***
(3.85) (5.16)
H_Tech 0.408*** 0.289***
(3.25) (2.72)
DCG × H_Comp 0.206*** 0.216***
(6.65) (7.87)
H_Comp -0.134 -0.162**
(-1.43) (-2.11)
CONTROLS Yes Yes Yes Yes
CONSTANT -11.089*** -9.645*** -11.123*** -9.697***
(-21.93) (-20.14) (-21.93) (-20.08)
YEAR & IND Yes Yes Yes Yes
OBS 15,259 15,259 15,259 15,259
ADJ-R2 0.516 0.488 0.510 0.480

transformation on innovation is more pronounced in high-tech companies.

In order to test this assumption, we conduct cross-sectional analysis according to whether the firm is in high-tech industries.
Specifically, following Wu et al. (2022), we set the dummy variable H_Tech. When the companies are in the high-tech industry, H_Tech
equals 1, otherwise equals 0. The regression results are shown in first two columns of Table 6. The coefficients of the interaction terms
(DCG × H_Tech) are both significantly positive at the 1% level, suggesting that the impact of digital transformation on corporate
innovation is more pronounced in high-tech industries.

5.2. The effect of industry competition

Intense industry competition imposes higher pressure on management and in turn can lead to management myopia, as well as
intensifies the financing constraints of enterprises. Therefore, we conjecture that the influence of digital transformation on innovation
is more pronounced in high competition industries.
To test the above prediction, we conduct cross-sectional analysis based on industry competition. Specifically, we set a dummy
variable H_Comp according to the industry competition calculated by the Herfindahl index. If the Herfindahl index is above the median
value, H_Comp equals 1, and otherwise equals 0. The results of the regression are shown in rest columns of Table 6. The coefficients of
the interaction terms (DCG × H_Comp) are 0.206 and 0.216, respectively, all significantly at the 1% level. The results indicate that the
impact of digital transformation on corporate innovation is more significant in fierce industry competition.

6. Conclusion

Using textual analysis method, this paper studies the relationship between digital transformation and corporate innovation based
on Chinese listed firms’ data from 2007-2019. Empirical results show that digital transformation significantly promotes corporate
innovation by alleviating financial constraints and improving corporate governance. Additionally, the positive association between
digital transformation and corporate innovation is more significant when firms are in high-tech industries and in high-competitive

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industries. This paper expands the literature on the determinants of corporate innovation and the economic consequences of digital
transformation. Moreover, the empirical outputs verify the importance of digital transformation on the innovation performance of
Chinese firms, providing insights for other emerging countries to promote the digital economy and innovation.

CRediT authorship contribution statement

Yuhao Niu: Conceptualization, Methodology, Data curation. Wen Wen: Conceptualization, Formal analysis, Writing – original
draft, Funding acquisition. Sai Wang: Writing – original draft. Sifei Li: Writing – review & editing, Funding acquisition.

Data Availability

Data will be made available on request.

Acknowledgements

We acknowledge financial support from National Natural Science Foundation of China (72002014), Fund for Humanities and
Social Sciences of Chinese Ministry of Education (20YJA630035), Fundamental Research Funds for the Central Universities in Beijing
Foreign Studies University (2022JJ011, 2022TD001, SYL2020ZX014), Fund of the Social Science Foundation of Beijing Municipal
(19YJC040), BFSU Double First-class Major Signature Research (2022SYLZD001), and Outstanding Talent Support Program of Beijing
Foreign Studies University.

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