Research from West Virginia University suggests that the dynamics of the stock market significantly influence the innovative commitments of chief executive officers through mechanisms such as CEO compensation packages and input from financial analysts.

Associate Professor of Marketing at WVU’s John Chambers College of Business and Economics, Xinchun Wang, notes that financial analysts’ feedback, like earnings forecasts, is often perceived as a barrier to innovation due to the pressure it exerts on CEOs. However, Wang clarifies that not all types of feedback hinder innovation. In contrast, stock recommendations encourage exploration and investment in areas such as research and development, which, although risky, may yield positive long-term returns.

In their study published in the Journal of the Academy of Marketing Science, Wang and a colleague explored how feedback from financial analysts affects CEOs’ strategic decisions. They discovered that analysts’ stock recommendations have a two-fold influence on management decisions: indirectly by affecting investor sentiment and stock prices and directly during meetings where analysts interact with management, posing questions or seeking clarifications on company strategies.

Wang highlights the attention management pays to stock recommendations, using the example of Goldman Sachs analysts advising the sale of Imax stock, which has prompted Imax’s CEO to focus on transforming the company’s business model to improve its rating. This emphasis on innovation over traditional models highlights the importance of feedback from financial analysts, who act as intermediaries between firms and investors, providing critical insights into current performance and potential future returns.

Unlike earnings forecasts focusing on short-term financial outcomes, stock recommendations are based on analysts’ long-term evaluations of a firm’s potential future cash flows, necessitating strategic rather than superficial, short-term CEO responses. Wang stresses that such long-term investment in innovation is crucial for a company’s success, exemplified by Adobe under CEO Shantanu Narayen. Despite initial revenue declines following its shift from license sales to a subscription-based model in 2013, Adobe’s revenues had soared by almost 500% by 2022, affirming the value of steadfast commitment to long-term strategic goals.

However, not all CEOs adhere to such long-term perspectives, often influenced by compensation structures that incentivise returns. In another study published in the Journal of Product Innovation Management, Wang examined the link between CEOs’ strategic myopia and their compensation methods, finding that CEOs nearing the exercise of stock options might reduce spending on innovation to boost stock prices temporarily and maximise gains—a practice Wang terms as myopic.

Wang also notes that CEOs who hold significant power, such as board positions, face less pressure to innovate and are more likely to engage in opportunistic strategies to serve their agendas. He cites a survey where a vast majority of corporate executives admitted they would slash spending on research and development, advertising, and maintenance to meet earnings targets, highlighting the adverse effects of compensation plans that reward short-term achievements and excessive executive power.

Nevertheless, Wang believes that a firm’s historical commitment to innovation and its cultural ethos can place its demands on a CEO’s strategies. He argues that boards of directors must alleviate performance pressures by reinforcing the importance of long-term innovative investments to their CEOs. Furthermore, stakeholders should vigilantly monitor a CEO’s actions, especially as they approach the period for stock options exercises, advocating for clear guidelines on the timing and methods of such exercises to curb myopic behaviour. This comprehensive oversight is essential to ensure that CEOs do not sacrifice the future sustainability of their companies for immediate financial gains.

More information: Xinchun Wang et al, The impact of analyst stock recommendations on firms’ relative exploration orientation, Journal of the Academy of Marketing Science. DOI: 10.1007/s11747-024-01070-5

Journal information: Journal of the Academy of Marketing Science Provided by West Virginia University