Ideas for Leaders #723

Less Competitive Pressure Leads to Less Innovation

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Key Concept

Taking advantage of the suddenly reduced threat of hostile takeovers of Delaware-incorporated companies, two researchers demonstrate the significant reduction of innovation efforts when competitive pressure is eased. In short, less competition leads to less innovation.

Idea Summary

How does competitive pressure impact innovation? To answer this question, two researchers, Kenneth Younge of the École polytechnique fédérale de Lausanne (EPFL) and Tony Tong of the University of Colorado Boulder Leeds School of Business, took advantage of a fortuitous series of court rulings in Delaware that eased the competitive pressure on firms incorporated in Delaware (where most U.S. firms are incorporated). The changes involved the ability of firms to fend off hostile takeovers. The rules gave firms two major weapons with which to fight off hostile takeovers:

  1. Poison pill: a process in which current shareholders can buy more shares at a discount to prevent outsiders from accumulating shares.
  2. Staggered election of boards: a procedural rule that results outsiders being unable replace a majority of a board in one election. 

With these two new weapons at their disposal, firms in Delaware were now much less subject to hostile takeovers. In other words, they suddenly did not face the same competitive pressure as before. 

The close proximity of these court rulings gave the researchers a unique ‘before’ and ‘after’ period for increased competitive pressure, with four ‘before’ years (1992 to 1995), and four ‘after’ years (1996 to 1999). In this eight-year window, the researchers accumulated annual firm-level data from Compustat, complemented with data related to patents, including inventor data.

Using this data, the researchers measured for each firm in their sample:

  1. The rate of innovation, based on both quantity of innovation (as measured by the number of patents) and quality of innovation. Quality of innovation was measured by forward citations — in other words, if future patents consistently cite a company’s patent, the innovative quality of that patent is clearly high.
  2. The scope of innovation, based on a number of different measures including patent classes (a higher number of unique patent classifications indicates the firm is negotiating in different technological areas), new inventors (inventors listed on the patents who were not on previous patents from that firm), and cross-border inventors (inventors listed on the patents who do not reside in the U.S., indicating that the firm is coordinating international R&D.)

The results of the research — based on the eight years of data for newly protected firms in Delaware as well as for a comparison list of firms not incorporated in Delaware (or Delaware firms who did not have staggered board elections) — indicate that firms who face less competitive pressure reduced both the rate and scope of their innovations. 

The reason can be found in the tendency of executives (as proven by previous research) to follow the path of least resistance. Executives have a high demand on their attention, and as a result, they seek out projects and initiatives that are less taxing. As a result, the middle managers charged with uncovering and presenting innovation initiatives to their executives are more likely to present less projects (reduced rate) and projects that require less effort (reduced scope). After all, a higher rate of innovations and innovation pursuits of greater scope require new executive learning and new executive routines.) 

The negative effect of reduced competitive pressure on innovation revealed by the researchers was attenuated by the size of the firm. In other words, larger firms were less likely to reduce their innovation efforts even when competitive pressure decreased. The reason for this is that innovation in larger firms is delegated down to mid-level managers who are less likely than high-level executives to be tempted by the easier path of reduced innovation effort, whether or not there is competitive pressure. 

Another attenuating factor was the product market competition that the firm faced. Firms operating in highly competitive product markets were also less likely to reduce their innovation efforts even if better protected against hostile takeovers. The reason for this is clear: whether or not hostile takeovers are a threat, the firm must respond to intense pressure from competitors.

Business Application

The barriers of innovation are often related to the wrong corporate culture, or perhaps to processes, such as compensation processes, that inhibit creativity and innovation. However, CEOs, business owners, board of directors and even shareholders and investors may want to be aware of the little-noticed human nature resistance to complexity and complications, translating into an inertia that can undermine a company’s innovation efforts. This inertia is especially pronounced, as this research demonstrates, when competitive pressure is reduced and executives are less fearful of losing their jobs.

As a result, any corporate leader, including board members, frustrated at the lack of innovation (or lacklustre innovation) in their companies may want to explore whether lack of competitive pressure is building up innovation resistance in their executives — or in the board itself. If so, executives and other decision makers should be encouraged to overcome this resistance, perhaps by linking compensation to innovation, or perhaps by reviving the ‘burning platform’ metaphor of the past: artificially creating competitive pressure, for example, by requiring that a certain percentage of revenues come from recently developed products.

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Authors

Institutions

Source

Idea conceived

  • March 2018

Idea posted

  • December 2018

DOI number

10.13007/723

Subject

Real Time Analytics