Innovation, Industry Equilibrium, and Discount rates
(with Maria Cecilia Bustamante)
SUERF policy brief

We develop a model to examine how aggregate discount rates affect the nature and composition of innovation within an industry. Challenging conventional wisdom, higher discount rates do not discourage innovation when accounting for the industry equilibrium. Higher discount rates deter entry—effectively acting as entry barriers—but encourage innovation through the intensive margin, which can lead to a higher industry innovation on net. Simultaneously, high discount rates foster explorative over exploitative innovation. Our predictions strengthen in industries with higher exposure to aggregate risk, for which the negative impact of discount rates on entry is stronger.

Dynamic Carbon Emission Management
(with Maria Cecilia Bustamante)
VoxEU column, ECB Research Bulletin, LSE Business Review, SUERF policy brief

Carbon regulation poses the corporate challenge of developing a carbon management policy. We provide a unified model characterizing how firms should optimally manage emissions through production, green investment of various types, and the trading of carbon credits. We show that carbon pricing generates incentives to reduce emissions but, as it becomes costlier to comply, it can also induce polluting firms to shift towards more immediate yet transient types of green investment—such as abatement instead of green innovation. Combining carbon pricing with green innovation subsidies can attain the twofold goal of reducing current emissions and supporting a faster transition to more sustainable technologies.

Financially Constrained Carbon Management
(with Maria Cecilia Bustamante)

We develop a model studying how financing frictions affect a firm’s carbon footprint as well as its transition to sustainable technologies, while allowing for multiple types of green investment: abatement of carbon emissions, adoption of available technologies, and green innovation. Financing frictions impact each type of green investment differently—with abatement unaffected, a negative effect on adoption, and an ambiguous impact on green innovation. Financing frictions reduce current emissions by contracting production, but have a negative impact on the transition to greener technologies in firms relying mainly on adoption. We further show tilting strategies need not boost green innovation, exclusion strategies mainly curb current emissions, and subsidies to adoption help incentivize green innovation too

The Monetization of Innovation 
(with Missaka Warusawitharana)
Supplementary Appendix

We develop a dynamic model for digital service firms, which invest in monetization to generate revenues from services provided to customers fully or partially for free. A key novelty of our model is that customer acquisition by firms need not translate directly into the generation of revenues. Our model explains why such firms often build a large customer base and become highly valued while continuing to suffer losses, fueled by substantial upfront SG&A expenditure with sizable though risky growth potential. Counterfactual analysis reveals that hurdles to monetization—such as regulation aimed at protecting customer privacy—make firm smaller and less innovative, whereas direct revenues from customers support technological advancement.

Dynamic Equity Slope
(with Matthijs Breugem, Stefano Colonnello, and Roberto Marfè)

We develop a general equilibrium model that jointly explains important features of the term structure of equity: (i) a negative unconditional term premium, (ii) countercyclical term premia, (iii) procyclical equity yields, (iv) premia to value and growth claims respectively increasing and decreasing with the horizon. The economic mechanism hinges on the interaction between heteroskedastic long-run growth—which steers countercyclical risk premia—and homoskedastic short-term shocks—which generate sizable short-term risk premia.  The slope dynamics hold irrespective of the sign of its unconditional average.  We provide empirical support to our model assumptions and predictions.

Corporate Policies and the Term Structure of Risk
(with Matthijs Breugem and Roberto Marfè)

Asset pricing research indicates that the long and short term do not contribute equally to the market risk premium and that their relative contribution is time-varying.  While having notable implications for firm discount rates, corporate finance models typically abstract from these aspects.  In a dynamic model with financing frictions, we show that firms should extend (shorten) their horizon if short-term shocks have a greater (smaller) market price than long-term ones, i.e., if the term structure of risk prices is downward-sloping. Ignoring a downward-sloping term structure leads to underinvestment, excessive payouts, inadequate cash reserves and equity issuances, and excessive liquidations.

Competition, Cash Holdings, and Financing Decisions 
(with Erwan Morellec and Boris Nikolov)

We use a dynamic model of cash management in which firms face competitive pressure to show that competition increases corporate cash holdings as well as the frequency and size of equity issues. In our model, these effects are driven by small, financially constrained firms, in contrast with the theories based on strategic interactions in which large leaders or incumbents value more cash. We test these predictions on Compustat firms and show that product market competition has first order effects on the cash holdings and financing decisions of constrained firms, in ways consistent with our theory.

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