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.'' Macroeconomic 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 discount 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 ownership 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.