Abstract

Prior research documents conflicting evidence that R&D investment both increases and decreases firm risk. We propose a parsimonious framework that explains this conflicting evidence. Initially, investing in innovation primarily creates idiosyncratic risk because whether a scientist successfully creates a novel innovation is unpredictable but does not depend on market fluctuations. However, the idiosyncratic risk of innovation investments becomes systematic over commercialization horizons because firms best commercialize nonrival innovations broadly, exposing them to systematic risk. Using state R&D tax credits as sources of plausibly exogenous variation in R&D investment and a measure of the horizon of innovation based on the delay between changes in R&D spending and patent filings, we document findings consistent with the framework’s predictions. Overall, we validate the long-standing assumption that R&D increases firm risk and further demonstrate that the risk of innovation evolves from idiosyncratic to systematic over time. Furthermore, the average horizon of R&D is about three years, considerably longer than assumed in many prior studies.

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• Keyword(s):
• accounting 126
• innovation 187

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