Campus News

Research shows that financial analysts can stifle innovation

Any number of things can affect a company’s ability to innovate: talent, commitment, luck and funding all play big roles. But new research from UGA shows that one factor outside a company has dramatic effects on its creativity: financial analysts.

In a paper recently published in The Journal of Financial Economics, researchers at UGA’s Terry College of Business show, contrary to conventional wisdom, how financial analysts can hamper companies’ likelihood to innovate.

“Before starting this project, we originally thought that analysts could perform two roles. One is good: Reducing information asymmetry. One is bad: Putting too much pressure on managers to be myopic and focus on only short-term projects,” said Jie (Jack) He, lead author of the research and an assistant professor of finance at the Terry College. “Our findings support that the negative effect dominates the positive.”

The findings show that the more financial analysts are monitoring a firm, the fewer patents it produces-and the patents it does produce tend to elicit fewer citations. To find out why, He and co-author Xuan Tian of Indiana University studied data from all industries from 1993 to 2005.

Forecasters often predict short-term earnings and make recommendations that put pressure on managers to meet these external expectations.

“Basically, they want to beat the earnings expectations set by these analysts,” He said. “So how do they meet these expectations? One way is to cut down on some long-term projects and focus more on the short-term projects, the easy and routine tasks the firm is engaging in.”

In other words, investing in innovation is a big commitment for firms. It requires lots of time and money, and results aren’t guaranteed. When firms are under the magnifying glasses of financial analysts, managers can find themselves under pressure to put more resources toward routine tasks that offer quick and certain returns.

The researchers also studied what happened when the number of analysts covering a firm changed.