The Innovation Consequences of Financial Regulation for Young Life-Cycle Firms

58 Pages Posted: 11 Jun 2018 Last revised: 27 Jul 2018

See all articles by Abigail M. Allen

Abigail M. Allen

Brigham Young University - Marriott School

Melissa F. Lewis-Western

Brigham Young University - Marriott School of Business

Kristen Valentine

University of Texas at Austin, McCombs School of Business, Department of Accounting

Date Written: May 25, 2018

Abstract

The last several decades have witnessed a striking uptick in reactionary financial regulation intended to curb financial misreporting by requiring increased external monitoring and centralized decision-making. We provide evidence that young life-cycle stage firms, characterized by low levels of financial slack and heavy investment in explorative innovation, are particularly vulnerable to negative innovation consequences from such regulation. Using SOX as a backdrop to test our predictions, we document a significant reduction in both R&D spending and innovation outputs for young life-cycle stage firms after regulation, relative both to their more mature counterparts and to young life-cycle stage firms exempt from full regulatory compliance. Additional tests indicate that the decline in innovation manifests both from a diversion of scarce resources and from the imposition of an organizational structure mismatched to the pursuit of explorative innovation. Importantly, we find no evidence that innovation declines are offset by other ensuing benefits to young life-cycle stage firms; across several measures, we fail to detect evidence of improved financial reporting quality. Moreover, an event study analysis suggests that market participants expected financial regulation to be incrementally value decreasing for young life-cycle stage firms, and post-regulation returns analysis corroborates this expectation. Supplemental tests of other regulatory settings yield consistent inferences. Collectively, our results support the notion that financial regulation places a heavy burden on innovative, young life-cycle stage firms.

Keywords: Firm Life-Cycle, Innovation, Explorative Innovation, R&D, Financial Regulation, Corporate Governance, Financial Reporting Quality

JEL Classification: G18, G30, G38, M41, M48

Suggested Citation

Allen, Abigail M. and Lewis-Western, Melissa Fay and Valentine, Kristen, The Innovation Consequences of Financial Regulation for Young Life-Cycle Firms (May 25, 2018). Available at SSRN: https://ssrn.com/abstract=3184837 or http://dx.doi.org/10.2139/ssrn.3184837

Abigail M. Allen

Brigham Young University - Marriott School ( email )

Provo, UT
United States

Melissa Fay Lewis-Western (Contact Author)

Brigham Young University - Marriott School of Business ( email )

Provo, UT 84602
United States
801-703-8426 (Phone)

Kristen Valentine

University of Texas at Austin, McCombs School of Business, Department of Accounting ( email )

2110 Speedway Stop B6400
Austin, TX 78712
United States

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