Financing Innovation: A Hurdle Rate Theory of Inventive Procyclicality
Authors:
Audretsch, D., Drobetz, W., Ernst, E. E., Momtaz, P. P., & Vismara, S.
Journal:
Research Policy
Summary:
Because a higher equity risk premium raises the hurdle rate that R&D projects must clear in corporate budgeting, elevated risk premia during downturns suppress corporate patenting---especially exploratory, long-horizon projects---explaining why innovation is procyclical.
Research Questions:
1. Does a higher aggregate equity risk premium (ERP) reduce the volume and value of corporate patenting?2. Is this relationship causal, rather than driven by reverse causality (patent value driving stock prices and hence the ERP)?
3. Does the ERP act on patenting directly, or indirectly through R&D expenditures?
4. Does the ERP effect fall more heavily on exploratory than on exploitative firms?
5. How do financial constraints, product-market competition, and institutional ownership moderate the ERP–patenting relationship?
What we know:
Schumpeter's "creative destruction" predicts innovation should be countercyclical, since downturns lower the opportunity cost of long-horizon R&D—yet decades of evidence show the opposite: patenting and R&D concentrate in booms. The mechanisms behind this procyclicality remain poorly understood, with prior explanations spanning supply-side financing constraints, strategic timing by innovators, innovation externalities, and procyclical inventor productivity. This matters to policymakers designing crisis interventions and innovation subsidies, to managers allocating R&D budgets over the cycle, and to scholars linking financing conditions to real innovative output.
Novel Findings:
The paper proposes a "hurdle-rate theory of inventive procyclicality": time variation in the ERP changes the discount rate applied in R&D capital budgeting, so fewer projects are NPV-positive when the ERP is high. A one-standard-deviation rise in the ERP lowers patent counts by ~14.7% and patent value by ~16.4% (aggregate correlations of ρ = –0.69 and –0.75). The effect concentrates in exploratory, high-technological-impact firms—reversing the Schumpeterian prediction. Contrary to prior work (Manso et al., 2023), exploratory innovation emerges as the most procyclical component: the financing-cost (hurdle-rate) channel dominates the opportunity-cost channel, and high-ERP episodes both shrink aggregate patenting and shift the surviving portfolio toward exploitation.
Novel Methodology:
Links forward-looking implied ERP to firm-level patenting. Causality is established through two strategies: (1) firm-specific peer-adjusted idiosyncratic return shocks used as granular instruments, exogenous by construction; and (2) a staggered difference-in-differences/Bartik design exploiting inventor-location-weighted state-level R&D tax credits that counteract the ERP's effect on the hurdle rate. A causal mediation analysis further separates the direct ERP effect from the indirect effect operating through R&D spending.
Implications for Practice:
Managers should recognize that rising risk premia mechanically inflate hurdle rates and disproportionately screen out long-horizon, exploratory projects—precisely those with breakthrough potential. Maintaining financial slack (internal funds, low-risk debt capacity) insulates innovation from market scrutiny and preserves exploratory R&D through downturns.
Implications for Policy:
The ERP is a first-order determinant of innovation investment and can moderate both crowding-in/crowding-out and direct-versus-indirect subsidy effects. Actionable levers to offset a high ERP: (1) expand financial slack via corporate tax cuts, R&D tax credits, and cash-easing subsidies; (2) partially shield firms from intense product-market competition (e.g., antitrust flexibility, protective tariffs); and (3) incentivize long-term institutional ownership (e.g., horizon-dependent capital-gains treatment). The paper also warns that aggressive monetary interventions (e.g., quantitative easing) may push the ERP up through negative signaling, neutralizing intended stimulus, and calls for coordination across policy agencies given narrow central-bank mandates (e.g., the ECB's price-stability-only mandate).
Implications for Society:
Because knowledge spillovers are a positive externality, ERP-driven underinvestment in innovation during downturns is socially costly, foregoing long-run growth. Protecting exploratory innovation—the component most vulnerable to elevated risk premia—during periods of economic uncertainty yields broad societal benefits.
Implications for Research:
Future work could characterize the trade-off between Schumpeterian opportunity costs and financing (hurdle-rate) costs—its functional shape and contingencies—identify firm-level policies that offset ERP constraints during crises, and separately examine the ERP's differential effects on R&D expenditure, patented inventions, and the commercialization of patents.
Full Citation:
David Audretsch, Wolfgang Drobetz, Eva Elena Ernst, Paul P. Momtaz, Silvio Vismara, Financing innovation: A hurdle rate theory of inventive procyclicality, Research Policy, Volume 55, Issue 8, 2026, 105565, ISSN 0048-7333, https://doi.org/10.1016/j.respol.2026.105565.
Abstract:
Schumpeterian arguments of “creative destruction” predict that innovation is countercyclical. However, empirical findings demonstrate the opposite. We apply corporate finance principles to innovation economics and propose a “hurdle-rate theory of inventive procyclicality.” In our 1977–2018 sample of U.S. firms, macroeconomic episodes of high equity risk premia (ERP) hinder innovation because many R&D projects fail corporate budgeting decisions when the aggregate discount rate is high. Using the staggered variation in state-level R&D tax credits, we conduct a difference-in-differences analysis to establish a causal link between the ERP and patent value. In line with our hurdle-rate theory, we demonstrate that high-ERP episodes negatively impact firms that focus on exploratory search more than their exploitative counterparts. Evidence consistently suggests that the hurdle rate effect is less pronounced in firms with financial slack, weak product market competition, and high institutional investor ownership.
https://doi.org/10.1016/j.respol.2026.105565