The Dark Side of Analyst Coverage: The Case of Innovation

Abstract

We examine the effects of financial analysts on the real economy in the case of innovation. Our baseline results show that firms covered by a larger number of analysts generate fewer patents and patents with lower impact. To establish causality, we use a difference-in-differences approach that relies on the variation generated by multiple exogenous shocks to analyst coverage, as well as an instrumental variable approach. Our identification strategies suggest a negative causal effect of analyst coverage on firm innovation. The evidence is consistent with the hypothesis that analysts exert too much pressure on managers to meet short-term goals, impeding firms’ investment in long-term innovative projects. We further discuss possible underlying mechanisms through which analysts impede innovation and show that there is a residual effect of analysts on innovation even after controlling for these mechanisms. Our paper offers novel evidence on a previously under-explored adverse consequence of analyst coverage — its hindrance to firm innovation.

Keywords: analyst coverage, innovation, patents, citations, managerial myopia

JEL Classification: G24, O31, G34