Financing Risk and Innovation

Nanda, Ramana; Rhodes-Kropf, Matthew

doi:10.2139/ssrn.1657937

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Financing Risk and Innovation

Management Science (Forthcoming)

44 Pages Posted: 13 Aug 2010 Last revised: 27 Aug 2015

See all articles by Ramana Nanda

Ramana Nanda

Imperial College Business School; Harvard University - Entrepreneurial Management Unit

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER)

Date Written: March 5, 2014

Abstract

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

Nanda, Ramana and Rhodes-Kropf, Matthew, Financing Risk and Innovation (March 5, 2014). Management Science (Forthcoming), Available at SSRN: https://ssrn.com/abstract=1657937 or http://dx.doi.org/10.2139/ssrn.1657937