Making Waves: To Innovate or be a Fast Second?

27 Pages Posted: 15 Mar 2012 Last revised: 8 Jan 2015

See all articles by Chris Yung

Chris Yung

University of Virginia - McIntire School of Commerce

Date Written: January 28, 2013

Abstract

I model an innovation game in which firms can choose to be leaders or followers. Internal finance leads to a stalemate in which each firm wants to free-ride on the others' experimentation costs. Therefore, no innovation occurs. When instead firms compete in the capital markets to finance innovation (e.g., in the case of venture capital or IPOs) there is an endogenous cost to delay. Waiting to make risky irreversible investment conveys pessimist information. I characterize the relative sizes of waves of leaders and followers in innovation cycles -- and the endogenous, intertemporal distribution of quality as each wave builds and crashes -- as a function of the risk of the innovation and the amount of external finance required. Finally, these waves create an adverse selection "hangover" so that too much early innovation can cause the market for later innovation to break down.

Keywords: Innovation, Entrepreneurship, Adverse Selection, Cycles

JEL Classification: E32, E44, E51, G21

Suggested Citation

Yung, Chris, Making Waves: To Innovate or be a Fast Second? (January 28, 2013). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2022267 or http://dx.doi.org/10.2139/ssrn.2022267

Chris Yung (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-242-0836 (Phone)

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