Shock Therapy for Clean Innovation: Within-firm Reallocation of R&D Investments

We analyze how a negative shock to the profitability of oil-extracting firms may lead to a shift from dirty to clean R&D along the supply chain. First, we develop a theoretical framework, showing that adjustment costs in R&D give firms in the fossil energy supply chain an additional incentive to shift R&D activity towards clean innovation as a consequence of a negative shock. Next, we leverage the 2014 oil price drop to empirically investigate the impact of reduced profitability in the fossil energy supply chain on clean R&D. We propose a novel method to identify firms’ exposure to the shock. In line with the predictions from the model, we find that more exposed firms increased their clean R&D more than other firms. Our findings imply that carbon pricing will nduce clean innovation not only by increasing demand for clean technologies, but also by lowering profitability in the fossil energy supply chain.