Do Short-term Incentives Hurt Innovation?

Abstract

We study how incentives to boost short-term performance affect longer-term innovation outputs. We find that incentives to meet current-quarter EPS targets using share repurchases are associated with an increase in the quality of future innovation outputs such as forward citation counts and the economic value of patents. These effects are concentrated among firms that are ex-ante more efficient at innovation, and associated with a shift in these firms’ innovation strategy. Firms are more likely to explore newer technologies and increase the breadth of knowledge sources and trademarks in the period after they face incentives to boost short-term performance. These effects on innovation are more positive among firms with more dedicated institutional investors, industries with shorter innovation life cycles, and firms with greater patent diversity. Our evidence illustrates that not all actions that appear short-termist have adverse long-term consequences but instead can have a bright side.

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

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