Financing Innovation: A Hurdle-Rate Theory of Inventive Procyclicality

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.” Macroeco-

nomic episodes of high equity risk premia (ERP) stifle innovation in our sample of U.S. firms

because many R&D projects do not pass corporate budgeting decisions when the aggregate dis-

count rate is high. Consistent evidence suggests that the discount rate effect is less pronounced in firms with financial slack, weak product market competition, and institutional investor own-

ership with long-term orientation. In an attempt to reconcile our procyclical empirical evidence

with Schumpeter’s countercyclical theory, we show that firms engaging in exploratory research

suffer less during high-ERP episodes than those focusing on exploitative research, 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.