The challenges involved in measuring innovation are legion, and this can be especially challenging in public companies that have reporting requirements.  New research from The Business School shows that relaxation in reporting frequency would help the long-term thinking that is so important for innovation to thrive.

The study found that when organizations impose frequent filing of financial accounts, it prompts managers to focus on the maximization of cursory gains rather than long-term strategy.  This significantly inhibits investment in innovation because managers worry about the impact of this on short-term expenditure.

By contrast, when reporting requirements are relaxed, this gives managers greater space to focus on longer-term goals rather than the short-term challenges that so worry shareholders.  This can result in an increase in investment in valuable and innovative projects.

Long-term bets

The researchers examined the number, value, and citations of patent applications filed by American firms during changes made to the financial regulatory requirements by the Securities and Exchange Commission during the 20th century.  This timeframe covered a range of reporting requirements, from annual reporting in 1934 through to semi-annual in 1955, and then finally quarterly in 1970.

The data allowed the researchers to assess the performance of those companies bound by these requirements and those that were not.  It revealed that the increase in reporting frequency was linked to a decrease of 1.87 patents per year, with each patent receiving on average 19.58 fewer citations.  This ultimately reduced the value of each patent by $1.76 million.

In other words, both the quantity and the quality of innovative output fell as organizations were required to report more frequently.  The researchers believe that this over-scrutiny can encourage organizations to adopt an excessively cautious approach.

“Increasing the frequency of reporting can increase transparency and generate external investment opportunities,” they explain.  “However, shareholders and financial regulators should consider the inhibiting factors this can have on managers and their performance motivations.”

The researchers highlight the COVID-19 pandemic as a clear example of a scenario that requires organizations to take a forward-thinking and long-term view of the world.

“Investments in innovation are initially expensive with research, development, and implementation costs, but they are necessary components for a company wishing to grow,” they say.  “Although nobody could have foreseen the events of 2020, it is plain to see that those who have been able to adapt business models and services to a socially distant population have generally fared better through the pandemic.”

Whatever the post-pandemic world will look like, it’s inevitable that managers will need to innovate and adapt to the changing world.  The study reminds us that managers need sufficient license to do this, and organizations need to be aware of the inhibiting consequences of excessive financial reporting.