The More Financial Analysts Cover a Company, the Worse It Is at Innovation

In an attention-seeking economy like this one, the presumption is that the more looks you get, the more you will prosper.

But it turns out that the kind of attention you get matters. A lot.

The focus of financial analysts, for instance, turns out to be bad for corporate health, assuming, that is, that innovation, long term growth and sustained viability are still considered positive attributes.

The data in the latest research on this subject demonstrate that the more financial analysts cover a company, the less likely it is to produce patents and that those produced are even less likely to be cited in academic journals or other patent filings, a key factor in patent importance.

The reasons for this will be well understood by anyone who has worked in an enterprise where the demands of outside investors take precedence over those of employees, supply chain partners and, dare we say it, customers. Excess financial analyst attention drives management to optimize the short term at the expense of the future. That means cutting down on research and development, training and all of the other institutional investments that strengthen an organization. Securities analysts are focused on now especially in an age of high frequency trading where the future is the present.

The more analysts' attention a business accrues, the more likely it is to be perceived as a hot asset from which gains can be siphoned as quickly as possible. This attitude tends to reduce innovation to a cost that must be borne by shareholders rather than an investment that can be harvested over the longer term.

In a global economy, one of the most significant advantages some societies possess is their ability to create marketable new products and services. Low wages and taxes, cheap real estate and government incentives can be found almost anywhere. But innovation generates higher margins and profits as well as a steady stream of future cash flows. Without them, no company or country can remain competitive. JL

Chris Valerio reports in Quartz:

The more financial analysts cover a company, the worse it is at innovating.
That’s one hypothesis you could arrive at by reading Harvard professor Clayton Christensen’s classic business tome The Innovator’s Dilemma.
Now researchers Jack He and Xuan Tian have lent statistical support to the idea, with a study tracking more than 2,000 publicly listed US companies over 12 years that measured innovation through the number of patents filed and the number of times each patent was cited in academic papers. (The more citations a patent receives, they reasoned, the more significant the technological breakthrough.)
In a recent paper published by the Journal of Financial Economics, He and Tian demonstrated that companies produce fewer, and less-significant patents the more financial analysts cover them. Their conclusion is that analysts—and their investor clients—have little tolerance for short-term failures, and company managers are sensitive to that. The result is that management is less likely to pursue the riskier long-term investments in areas such as research and development that lay the groundwork for innovation.
“That pressure to meet short-term earnings targets outweighs the benefits offered by analyst coverage,” says He, an assistant professor at the Terry College of Business at the University of Georgia. Benefits of analyst coverage include transparency of corporate information, which has historically been touted as a way to keep managers of public firms innovating.
Twitter CEO Dick Costolo, whose company filed to go public, recently told TV interviewer Katie Couric, “I don’t try to get caught up in short-term thinking about the company; we have a very specific goal on the horizon that we are trying to guide the company towards.”
Equity analysts are gearing up to cover the company as it approaches its IPO. If he wants to keep the internet firm innovating, Costolo should hope that coverage on his stock stays low.