Government debt and the returns to innovation

• Published in: Journal of financial economics Vol. 132; no. 3; pp. 205 - 225
• Main Authors: Croce, M.M., Nguyen, Thien T., Raymond, S., Schmid, L.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-06-2019; Elsevier Sequoia S.A
• Subjects: Asset pricing; Capital; Companies; Cross section of stock returns; Deficit financing; Economic growth; Endogenous; Fiscal policy; Fiscal uncertainty; Government debt; Growth; Innovations; Long term; Predictability; Premiums; Productivity; Prospects; R&D; Research & development; United States > US; Cross section of stock returns; E62; R&D; Government debt; Fiscal uncertainty; Predictability; Growth; H32; O33
• ISSN: 0304-405X; 1879-2774
• DOI: 10.1016/j.jfineco.2018.11.010

Elevated levels of government debt raise concerns about their effects on long-term growth prospects. Using the cross-section of US stock returns, we show that (i) high-R&D firms are more exposed to government debt and pay higher expected returns than low-R&D firms, and (ii) higher levels of the debt-to-GDP ratio predict higher risk premiums for high-R&D firms. Furthermore, rises in the cost of capital for innovation-intensive firms predict declines in subsequent productivity and economic growth. We propose a production-based asset pricing model with endogenous innovation and fiscal policy shocks that can rationalize key aspects of the empirical evidence. Our study highlights a novel and distinct risk channel shaping the link between government debt and future growth.