New research from West Virginia University reveals that stock market dynamics significantly influence how chief executives approach innovation. These effects stem from mechanisms like CEO pay structures and feedback from financial analysts.
While financial analysts’ earnings forecasts are often seen as barriers to innovation, stock recommendations tell a different story. The study found that recommendations, which assess a firm’s long-term potential, encourage risky but promising investments like research and development (R&D).
“Stock recommendations foster exploration,” the researchers explain. “Unlike earnings forecasts, which push CEOs toward short-term goals, stock recommendations reward long-term strategic changes.”
Shaping strategy
The research highlights two ways analysts shape corporate strategy: indirectly, by swaying investors and affecting stock prices, and directly, through interactions with management. For example, analysts’ ongoing sell recommendation for Imax stock has prompted its CEO to emphasize efforts to innovate beyond the traditional movie-theater business model.
One key finding is the long-term impact of innovation. Consider Adobe: after shifting to a subscription model in 2013, its revenues dropped for two years. Yet CEO Shantanu Narayen stayed the course, and by 2022, revenue had soared nearly 500%.
However, many CEOs, incentivized by pay packages tied to stock performance, prioritize immediate gains over sustainable growth. In a related study published in the Journal of Product Innovation Management, researchers found that CEOs nearing the exercise date for stock options often cut R&D spending to inflate short-term earnings and boost stock prices.
“When CEOs cut innovation budgets to raise stock prices before exercising options, that’s myopia,” the authors warn. Such behavior has led to infamous scandals, like WorldCom’s Bernard Ebbers, who inflated earnings to manipulate stock prices for personal gain.
Less pressure
The study also found that powerful CEOs—those who also hold board positions—face less pressure to drive innovation and are more likely to focus on personal goals. A survey of 400 executives revealed that 80% would cut R&D or other key investments to meet short-term earnings targets.
“Compensation plans that reward short-term gains, combined with unchecked CEO power, create a perfect storm for myopia,” the researchers caution. They recommend stricter oversight, including guidelines for stock option exercise and closer monitoring of CEO decisions.
Firms with a strong innovation culture can counteract these pressures by signaling the importance of long-term investments. Boards of directors play a critical role in maintaining this focus, particularly when performance concerns arise.
“Stakeholders must stay vigilant as CEOs approach stock option deadlines,” the researchers conclude. “Innovation is essential to long-term success, and companies must ensure it isn’t sacrificed for short-term profits.”
