The Impact of Financial Fraud on Technological Innovation: Myopia, Job Security, and Loss of Trust

Given the profound effects of financial fraud on corporate managers, inventors, and cultures, this paper investigates how financial fraud influences technological innovation at both firm and inventor levels. We find that the occurrence of financial fraud is negatively related to firms’ and inventors’ innovation outputs, both quantitatively and qualitatively. This finding is attributed to the negative impact of fraud on individual inventors’ productivity and the number of inventors deployed. Moreover, cross-sectional tests suggest that such impact is more pronounced when top-level management’s tone is more myopic, when fraud is more observable to employees, or when trust between inventors and firms is lacking. Our results hold when we implement an instrumental variable regression based on the SEC’s past enforcement activities and when we include various controls that reflect alternative explanations. In conclusion, our study implies that financial fraud not only hurts shareholders but also damages valuable human capital and results in “brain drain”.