Financing Experimentation

44 Pages Posted: 6 May 2010 Last revised: 20 Oct 2012

See all articles by Mikhail Drugov

Mikhail Drugov

Centre for Economic Policy Research (CEPR); New Economic School (NES)

Rocco Macchiavello

University of Oxford - Nuffield Department of Medicine; Centre for Economic Policy Research (CEPR)

Date Written: October 17, 2012

Abstract

Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "no-compete" clauses cannot be enforced ex-post, we show that financing experimentation can become harder precisely when it is more profitable, i.e., for lower values of the known-arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in micro-credit schemes) are shown to be part of the optimal contract.

Keywords: Experimentation, Moral Hazard, Adverse Selection, Starting Small, Competition

JEL Classification: D81, D86, G30

Suggested Citation

Drugov, Mikhail and Macchiavello, Rocco, Financing Experimentation (October 17, 2012). Available at SSRN: https://ssrn.com/abstract=1600881 or http://dx.doi.org/10.2139/ssrn.1600881

Mikhail Drugov (Contact Author)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

New Economic School (NES) ( email )

100A Novaya Street
Moscow, Skolkovo 143026
Russia

Rocco Macchiavello

University of Oxford - Nuffield Department of Medicine ( email )

New Road
Oxford, OX1 1NF
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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