Companies with more financial analysts invest more efficiently in innovation and produce a higher number of better-quality patents, according to a recent study.
Researchers from the Universidad Carlos III de Madrid (UC3M), in collaboration with the Universidad Autónoma de Barcelona (UAB), explored the role of financial analysts on firms’ innovation strategy and outcome.
The team used data of US firms from 1990 to 2012. They found evidence that an increase in financial analysts leads companies to reduce research and development expenses, invest in corporate venture capital, and acquire more innovative firms.
They also found that financial analysts can encourage companies to more efficiently make investments in innovation. This can help boost future patents and citations and has an influence on the novelty of their innovations.
Financial analysts influence innovation activity in two different ways.
There is an information effect in which analyst coverage can increase CEOs’ incentives to invest in innovation more efficiently. There is also a pressure effect through periodic earnings forecasts that discipline managers’ behavior, putting pressure to meet analysts’ earnings targets – in some cases this can cut spending in innovation.
“There is a tension because financial analysts can have a positive as well as a negative effect on firms’ innovation decisions,” said one of the authors, Anna Toldrà-Simat from the Business Administration Department of UC3M.
Positive information effect seems to dominate the negative pressure effect
“The positive information effect seems to dominate the negative pressure effect”, said Anna Toldrà-Simats.
Bing Guo, another author of the study also from the Business Administration Department of UC3M, commented: “We have found that companies followed by more financial analysts are more likely to acquire other innovative companies, make corporate venture capital (CVC) investments, and reduce internal R&D expenses with little value added, which leads to a more efficient allocation of R&D resources.”
Professor David Pérez Castrillo, the other co-author from UAB, said “our study suggests that the disciplinary role of financial analysts leads companies to externalise their innovation activities, to make them more visible to the market. A certain level of supervision leads companies to make efficient decisions, also in terms of innovation”.
Bing Guo, David Pérez-Castrillo, Anna Toldrà-Simats, “Firms’ innovation strategy under the shadow of analyst coverage”, Journal of Financial Economics, Volume 131, Issue 2, 2019, Pages 456-483, ISSN 0304-405X, https://doi.org/10.1016/j.jfineco.2018.08.005.