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Abstract

We utilize a novel identification strategy to analyze the impact of assets in place on firms' decisions for future projects. We exploit the context in the pharmaceutical industry, where the loss of market exclusivity for a branded drug can be used to separate the impact of cash flows generated by a firm's current assets in place from the characteristics of its future investment opportunities. We first show that around the exclusivity losses in our sample of large drugs, the affected firms' profitability drop significantly. The timing of this profitability decrease was predetermined many years ago, and therefore, arguably independent of current investment opportunities. Nevertheless, we find that R&D spending drops by approximately 25% over two years following the loss of exclusivity. We also find that stock repurchases and cash balances decline significantly. Our findings do not support the predictions of traditional capital budgeting, but are more consistent with the pecking order theory. These results further point to a lack of long-term lifecycle management that could mitigate the effect of predictable negative shocks to cash flows.