Study: When private companies go public, innovation suffers

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A surprising new study found that after companies go public, the rate of innovation actually declines.

Paradoxically, undergoing an IPO, which enables an influx of investor funds and the potential to garner wider interest, typically puts the company in a better position to innovate. The reasons for why this doesn't happen appear quite complex and involve a transitional shift in the overall approach to innovation as well as company culture.

The study, conducted by Finance professor Shai Bernstein at the Stanford Graduate School of Business, looked at the patenting patterns of 2,000 public and private U.S. tech firms between 1983 and 2006. He also analyzed data on the inventors listed on the patents.

"I find a signinficant link between public ownership and innovation: going public causes a substantial decline of approximately 40 percent in innovation novelty as measured by patent citations," he writes in the paper. "At the same time, I find no change in the scale of innovation, as measured by the number of patents. These results suggest that the transition to public equity markets leads firms to reposition their R&D investments toward more conventional projects."

After going public, the new strategy to innovation gets re-calibrated in a manner geared toward minimizing risks like opting for incremental and less ambitious improvements instead of pushing for bolder potential breakthroughs. He also observed a tendency for companies to switch towards buying up other companies and assimilating their ideas. The big tech giants like Google and Microsoft come to mind in regards to cultivating some of their new ideas through acquisitions.

On the business end, being accountable to a board of investor's puts company heads in a position where achieving results becomes more of a priority. So in turn, inventors either adapt or head elsewhere where their work can be more beneficial, Bernstein explains in the paper.

Breaking it down, the finding is not as much of a surprise or as counterintuitive as it seems. The bigger a company gets, the more cautious it becomes. And real innovation, by its very nature, is risky.

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