Financing Risk and Innovation
Management Science (Forthcoming)
44 Pages Posted: 13 Aug 2010 Last revised: 27 Aug 2015
Date Written: March 5, 2014
We provide a model of investment into new ventures that demonstrates why some places, times and industries should be associated with a greater degree of experimentation by investors. Investors respond to financing risk ― a forecast of limited future funding ― by modifying their focus to finance less innovative firms. Potential shocks to the supply of capital create the need for increased upfront financing, but this protection lowers the real option value of the new venture. In equilibrium, financing risk disproportionately impacts innovative ventures with the greatest real option value. We propose that extremely novel technologies may need `hot' financial markets to get through the initial period of discovery or diffusion.
Keywords: Innovation, Venture Capital, Investing, Experimentation, Market Cycles, Financing Risk
JEL Classification: G24, O31
Suggested Citation: Suggested Citation