Innovation Under Pressure

Firms become more efficient at innovation activities when they face pressure to meet earnings per share (EPS) targets using stock repurchases. Using a regression-discontinuity framework, we find that incentives to engage in “EPS-motivated buybacks” are followed by more citations and higher values for firms’ new patents. We trace these effects to improved allocation of R&D resources and a greater focus on novel innovation. The positive effects are concentrated among ex ante “innovation-efficient” firms that achieve better patenting outcomes after reorganizing (but not cutting) their R&D investments. Our findings illustrate that short-term earnings pressure can act through a free cash flow channel that motivates more efficient spending.