The hurdle-rate effect on patents: Equity risk premium and corporate innovation by public firms in the U.S., 1977-2018

HFRC Working Paper Series | Version 05/2023


We document high economy-wide correlations between the Equity Risk Premium (ERP) and the aggregate volume (rho=-0.69) and value (rho=-0.75) of patenting activity by public firms in the United States over the 1977-2018 period, contradicting Schumpeter's (1939) opportunity-costs hypothesis of countercyclical inventive productivity in a representative sample. We propose a ''hurdle-rate theory of inventive procyclicality'' and offer supportive evidence at the firm level. High-ERP periods stifle innovation because many R&D projects do not pass corporate budgeting decisions when discount rates are high. Consistent evidence suggests that the hurdle-rate effect is less pronounced in firms with financial slack, institutional ownership with long-term orientation, and weak product-market competition. In an attempt to reconcile the procyclical evidence with Schumpeter's countercyclical theory, we show that firms engaging in exploratory search suffer less during high-ERP episodes than those focusing on exploitative search, and patents developed during high-ERP periods have a higher technological impact and receive significantly more forward citations. Finally, we exploit the staggered variation in state-level R&D tax credits in difference-in-differences analyses to establish a causal link between the ERP and patent value.