The Direct Effects of Equity Markets on Innovation

Abstract

I examine the influence of equity markets on investments in innovation using drug development data. I find that market downturns following phase I clinical trial announcements lead to a 50% reduction in the likelihood of continued development, even though these downturns are unlikely to affect underlying project value. I also show that these investment distortions have positive spillover effects onto competing firms, as investment into drug classes most affected by market downturns increases dramatically over the next two years. My results show that market cyclicality can result in capital constraints that have widespread effects on innovation.

Keywords: Investment, Innovation, Market Downturns, Spillover Effects, Pharmaceutical Industry, Product Market Competition

JEL Classification: C26, D53, E44, G01, G14, G32, O16, O32