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


Schumpeterian arguments of “creative destruction” predict that innovation is countercyclical. However, empirical findings demonstrate the contrary. We apply corporate finance principles to innovation economics and propose a “hurdle-rate theory of inventive procyclicality.” Macroeconomic episodes of high equity risk premia (ERP) 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.