Abstract:
When firms face the threat of future regulation, what do they do? Two critical channels of response have been recognized: firms may innovate to capture a new market created by regulation, or they may lobby to influence regulation. This paper recognizes for the first time that firms must trade off these two actions as they develop their strategic response to uncertain, future regulation. I write down a simple theoretical model that describes a firm’s strategic response to uncertain future regulation. I then empirically estimate firm responses using a novel identification strategy: first scientific discoveries of previously unknown harms from products already adopted in markets. To estimate the model, I construct a new dataset of scientific discoveries by scraping scholarly publications from the web, and reviewing over 7,000 scientific publications to identify the first discoveries of low-dose, chronic exposure effects of a wide range of chemicals used in many disparate sectors of the economy. The timing of these information shocks and which firms are affected by them are used as plausibly random variation in estimation. I find that firms increase both innovation and lobbying investments in response to these information shocks over future regulation. However, I also find that a history of extensive lobbying drives the innovation response point-estimate to zero, suggesting that the option to lobby does indeed drive substitution by firms away from investments in innovation.