Venture Capitalists, Asymmetric Information and Ownership in the Innovation Process

37 Pages Posted: 21 Nov 2007

See all articles by Simona Fabrizi

Simona Fabrizi

Massey University

Steffen Lippert

University of Auckland Business School

Pehr-Johan Norbäck

Research Institute of Industrial Economics (IFN)

Lars Persson

Research Institute of Industrial Economics (IFN); Centre for Economic Policy Research (CEPR)

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Abstract

This paper constructs a model where entrepreneurial innovations are sold into oligopolistic industries and where adverse selection problems between entrepreneurs, venture capitalists and incumbents are present. We first show that aggressive development of a basic innovation by better informed venture-backed firms is used as a signaling device to enhance the sale price of the innovation. We then show that incumbents can undertake early, preemptive, acquisitions to prevent such signaling driven overinvestment, despite the risk of buying a non-productive innovation. Therefore, to exist in equilibrium, venture capitalists must be sufficiently more efficient in selecting innovation projects, otherwise preemptive acquisitions will take place.

Keywords: venture-backed firm, innovation, signaling, overinvestment, interim development, M&A

JEL Classification: C7, D21, D82, G24, L2, M13, O3

Suggested Citation

Fabrizi, Simona and Lippert, Steffen and Norbäck, Pehr-Johan and Persson, Lars, Venture Capitalists, Asymmetric Information and Ownership in the Innovation Process. Massey U. College of Business Research Paper No. 22, Available at SSRN: https://ssrn.com/abstract=1031533 or http://dx.doi.org/10.2139/ssrn.1031533

Simona Fabrizi

Massey University ( email )

Auckland
New Zealand
+64 9 414 0800 Ext 9335 (Phone)
+64 9 441 8177 (Fax)

HOME PAGE: http://www.massey.ac.nz/~sfabrizi

Steffen Lippert (Contact Author)

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Pehr-Johan Norbäck

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

Lars Persson

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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