Shakeouts and Staggered Exits from an R&D Race with Moral Hazard

50 Pages Posted: 23 Apr 2020 Last revised: 6 Sep 2023

Date Written: September 4, 2023

Abstract

This article analyzes the interaction between competition and agency frictions in R&D, which is often experienced by young and externally funded firms. Symmetric cash-constrained firms compete to access a profitable market in a continuous-time R&D race with stochastic breakthroughs. Each firm is funded by a different investor. R&D efforts are subject to moral hazard, and the investors make mutually optimal incentive-compatible contract offers. The profitable market accommodates more than one firm. If entering first is very valuable (relative to entering second), investors set asymmetric funding deadlines, resulting in staggered exits from the race when no breakthrough occurs for a sufficiently long time. If entering first is not that valuable, some deadlines are symmetric, leading to shakeouts. The comparative statics follow from a contractual externality and the cost of moral hazard. The model speaks to asymmetries in VC contracts and the phenomenon of industry shakeouts.

Keywords: Continuous-Time Race, Multiple Prizes, Market Entry, External Funding, Moral Hazard, Multiple Principals

JEL Classification: C73, D86, O3

Suggested Citation

Häfner, Samuel, Shakeouts and Staggered Exits from an R&D Race with Moral Hazard (September 4, 2023). Available at SSRN: https://ssrn.com/abstract=3564033 or http://dx.doi.org/10.2139/ssrn.3564033

Samuel Häfner (Contact Author)

University of St. Gallen ( email )

Varnbuelstr. 14
Saint Gallen, St. Gallen CH-9000
Switzerland

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