N°23-86: Data Innovation Complementarity and Firm Growth

This paper examines how complementarity between a firm’s general innovation and data-security innovation affects firm outcomes in the modern data economy. Our theoretical model shows that when the importance of data and its protection increases, firms with high complementarity between data-security and non-data-security innovation enter a virtuous cycle. They take advantage of this complementarity to improve their broader predictive capabilities and extend their productivity frontier. Empirically, we propose a novel firm-level measure of data innovation complementarity based on the intersection of patent inventors who work on both data-security-related and non-data-security related patents. Leveraging the staggered introduction of Data Breach Notification Laws (DBNLs) across U.S. states as a quasi-exogenous shock, we provide robust empirical evidence that heightened incentives to protect in-house generated data activates this feedback loop. We find that firms with complementary data innovation processes experience significant increases in (overall) innovation and profitability, by not only enhancing their in-house data security measures but also integrating these innovations across other domains. In contrast, firms without complementary data experience negative effects from the data protection laws. Our results highlight the dual role of data in driving firm-level market power and innovation dynamics.