Abstract

We study the effect of analyst coverage on firms’ innovation strategy and outcome. By considering three different channels that allow firms to innovate: internal R&D, acquisitions of other innovative firms, and investments in corporate venture capital (CVC), we are able to distinguish between the pressure and information effect of analysts. Using the data of US firms from 1990 to 2012, we find evidence that: i) an increase in financial analysts leads firms to cut R&D expenses, and ii) more analyst coverage leads firms to acquire more innovative firms and invest in CVC. We attribute the first result to the effect of analyst pressure, and the second to the informational role of analysts. In line with the previous literature, we also find that analyst coverage has a negative effect on firms’ future patents and citations; however, this negative effect becomes not significant when firms’ in-house R&D spending and external innovation channels are taken into account. We find that more financial analysts encourage firms to make more efficient investments related to innovation, which increase their future patents and citations. We address endogeneity with an instrumental variables approach and a difference-in-differences strategy where exogenous variation in analyst coverage comes from brokerage house mergers.