The Innovation Consequences of Financial Regulation for Young Life-Cycle Firms
58 Pages Posted: 11 Jun 2018 Last revised: 27 Jul 2018
Date Written: May 25, 2018
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: Suggested Citation