The impact of analyst stock recommendations on firms’ relative exploration orientation

Abstract

To better understand the impact of financial analysts on firm innovation, we examine an often-overlooked relationship between stock recommendations and firms’ strategic emphasis on exploration over exploitation. In contrast to studies suggesting that firms respond to earnings forecasts in a myopic manner that reduces R&D spending and hurts innovation, we show that low stock recommendations motivate firms to emphasize exploration despite the risks. The degree to which firms’ responses follow this behavioral-theory-based prediction is contingent on CEOs’ motivation and ability in strategic decision-making. Governance mechanisms, including equity compensation and institutional ownership, align CEOs’ personal interest with firm interest and motivate them to choose the predicted response. Marketing department power enhances CEOs’ ability to choose the predicted response because it enables the use of market knowledge to evaluate benefits and risks of exploration and exploitation. The findings contribute to research on financial analysts, the role of marketing, and exploration/exploration strategy.