Long-term growth in profits depends significantly on firms’ investment in innovation activities. However, firms may not invest in innovation in an optimal way. Some distortions arise because the decisions as to whether and how to invest in innovation are not only affected by their long-term expected benefits but also by other considerations. Among the factors that can distort firms’ incentives to innovate, the recent literature has highlighted the recommendations or reports issued by financial analysts.

There are two distinct effects through which analyst coverage influences firms’ innovation activity. On the one hand, there is an information effect. Analysts collect firms’ information and provide it to the investors, for instance, by writing reports about company activities. As a result, they reduce the information asymmetries and decrease the possibility of market undervaluation of the investments in innovation, which increase a CEO’s incentives to innovate. On the other hand, there is a pressure effect. Analysts discipline managers’ behavior through issuing periodic earnings forecasts. Missing the earnings forecasts is usually punished by investors. However, since investments in innovation do not usually generate short-term income, managers have an incentive to cut expenditures in innovation when they have the pressure to meet analysts’ earnings targets.

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