Innovation under Pressure

Abstract

This paper shows that firms become more efficient at innovation activities when they face pressure to meet earnings per share (EPS) targets using stock repurchases. Using a regression-discontinuity framework, we find that incentives to engage in “EPS-motivated buybacks” are followed by more citations and higher values for a firm’s new patents. We trace these effects to improved allocation of R&D resources and a greater focus on novel innovation. The positive effects are concentrated among ex-ante ‘innovation-efficient’ firms that achieve better patenting outcomes by reorganizing (but not cutting) R&D investments and paying for their EPS-motivated repurchases through reduced spending elsewhere. Our findings illustrate that short-term earnings pressures and resource constraints can spur managers to focus R&D spending more efficiently.

Keywords: Innovation, short-termism, EPS management, patents, trademarks, exploration

JEL Classification: G31, O31, G35, M20, M41