Undiversifiable risk widens hurdle rate gap and slows growth
Undiversifiable risk and pledgeability frictions create a widening gap between corporate hurdle rates and the financial cost of capital, according to research from the Banco de España. This discount-rate wedge weakens creative destruction, slowing productivity growth while raising superstar valuations.
Two frictions split investment and market rates
Firms discount research and development at hurdle rates that substantially exceed their market cost of capital, with the aggregate gap widening from roughly 1.0 percent in 1990 to 6.0 percent in 2021.
The authors construct a Schumpeterian model calibrated to a benchmark real cost of capital of 5.20 percent and a discount-rate gap of 2.64 percent.
Two core frictions generate this divergence: decision-makers demand a risk premium for undiversifiable idiosyncratic innovation risk, while profits from innovation remain imperfectly pledgeable with an estimated pledgeability share of 3.81 percent.
When idiosyncratic risk increases, precautionary savings depress the market cost of capital, whereas internal hurdle rates remain sticky or rise, reducing research intensity across firms.
Durable leadership and rising superstar values
The asymmetric adjustment of discount rates weakens creative destruction by discouraging innovation among laggards and new entrants.
Because follower advances are often non-incremental, reduced competition widens technology gaps and makes market leadership more durable.
This mechanism simultaneously explains slowing aggregate productivity growth and rising markups.
Furthermore, equity valuations for top superstar firms increase despite firms forgoing positive net present value projects, as lower market discount rates and entrenched profit flows more than compensate for subdued growth.
Finance explains the growth paradox
The paper convincingly explains why falling interest rates failed to revive productivity growth.
Targeting managerial risk exposure offers a far more coherent diagnostic than standard market power narratives.
Monetary policy cannot stimulate innovation if corporate hurdle rates remain stubbornly detached from market yields.