Competition and R&D Financing Decisions: 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. Motivated by existing theories, we develop several empirically testable hypotheses. The key predictions are that, as competition increases, R&D-intensive 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. We first establish stylized facts using time-series evidence that is consistent with these predictions. To address 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 then provide further evidence supporting these predictions through a differencesin-differences analysis.