Andy Hultgren, UChicago

Abstract:
It is well understood that environmental regulation may induce firms to innovate. A separate literature recognizes that profit-maximizing firms facing regulation will strategically lobby decision makers, in an effort to influence the regulatory outcome. This paper bridges these two literatures, recognizing that firms facing an uncertain regulatory future must trade off investments in innovation against investments in lobbying. Clearly, lobbying may have distortionary effects to the extent that it causes regulators to deviate from optimal regulation. I show, however, that a firm’s lobbying must also change the payoff to its own innovation investments; with additional spillover effects on the innovation investments of other firms. The sign of the effect is determined by whether lobbying and innovation are compliments or substitutes in production. Given the importance of innovation in driving the rate and direction of economic growth, the distortionary effect of a firm’s lobbying efforts on its own innovation investments and on those of other firms may have important welfare implications. I employ a novel identification strategy to empirically test for firm innovation and lobbying responses to the uncertain prospect of future regulation. Empirically, information shocks are represented by scientific discoveries of adverse health effects associated with commonly used products. In initial results based on a pilot sample, I find that annual R&D investments of treated firms increase by 6% over a five-year period. Lobbying increases by 40% over a 1.5 year period, a 25% increase in average annual lobbying for treated firms.