The Innovation Consequences of Financial Regulation for Young Life-Cycle Firms

Abstract

Firm life-cycle stage reflects a firm’s current strategic direction towards exploration independent of age or size. We provide evidence that young life-cycle firms are particularly vulnerable to negative innovation consequences from financial regulation but do not appear to experience any compensating financial reporting quality benefits. Using a generalized difference-in-differences design around SOX, we document a significant reduction in both R&D spending and innovation outputs for young life-cycle stage firms after regulation. Declines in innovation manifest both from the diversion of scarce resources and from the imposition of an organizational culture mismatched to the pursuit of explorative innovation, resulting in a less generalizable and less diversified patent portfolio. However, we find no evidence that improvements to financial reporting quality materialize to offset these costs. Event study analyses suggests that this negative impact was expected by market participants, and post-regulation returns confirm this expectation.