If it’s true that going public can having a chilling effect on innovation, it’s time to start asking who might be responsible for that innovation deficit. According to one new study, the blame lies with fiscally conservative financial officers and cautious chief executives.
Adopting a very conservative accounting style can have long-term effects on growth, says Gilles Hilary, associate professor of accounting & control at INSEAD. Hilary and co-authors Xin Chang and Jun Koo Kan of Nanyang Business School in Singapore and Wenrui Zhan of Xiamen University in China tracked more than 70,000 publicly traded U.S. companies from 1976 to 2006 and found that the more conservative a company was with its accounting procedures, the greater the impact it had on its ability to innovate. In the most common example of overly cautious accounting, companies “recognize bad news right away,” says Hilary, taking full writedowns on losses immediately rather than spreading the hit over a few years.
To measure innovation, the scholars looked at patent filings and citations, R&D spending, and cash flow. Businesses with the most conservative accounting approach filed about 10 percent fewer patents and had fewer patent citations. They invested less in R&D, and, the study found, the cash flows generated by the fruits of this R&D tended to have shorter horizons. “For the very conservative firms, cash flows from patents are realized 1-2 years out. For the more liberal firms, the cash flow from patents is realized 5-6 years out,” Hilary adds. “It means you have safer companies, but fewer blockbuster innovations.”
Hilary says the research even enabled them to pinpoint the innovation deficit at companies run by chief executives on the verge of retirement whose compensation was closely tied to short-term financial performance goals. For CEOs in this position, the general trend showed a reduction in R&D spending to boost the bottom line in the short term, hoping the move would be cheered by investors driving up the share price, Hilary says.
“People usually think of financial conservatism as a good thing, because it ensures management is not wasting money on certain projects, but there are drawback,s too,” Hilary says.