Competition and R&D Financing Decisions: Theory and Evidence from the Biopharmaceutical Industry

How does competition affect innovation and how it is financed in R&D-intensive firms? We study the interaction between competition, R&D investments, and the financing choices of such firms using data on biopharmaceutical firms. To motivate the empirical hypotheses, we develop a model for such firms in which their capital structure and amounts invested in R&D as well as existing assets are all determined in response to the degree of competition in the industry. The key predictions are that, as competition increases, such firms will: (1) increase R&D investment relative to investment in assets-in-place that support existing products; (2) carry more cash and maintain less net debt; and (3) experience declining betas but greater total stock return volatility due to higher idiosyncratic risk. While the focus is on the biopharmaceutical industry, the results are broadly applicable to other R&Dintensive industries as well. We provide empirical support for these predictions. In order to deal with the endogeneity issue introduced by the fact that a firm's R&D investments and the product-market competition it faces influence each other, we provide further evidence through a differences-in-differences analysis.