Innovation Policies

AiSM Special Issue on Entrepreneurship, Innovation and Platforms, Forthcoming

Harvard Business School Entrepreneurial Management Working Paper No. 13-038

53 Pages Posted: 11 Dec 2012 Last revised: 28 Mar 2017

Ramana Nanda

Harvard University - Entrepreneurial Management Unit

Matthew Rhodes-Kropf

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

Multiple version iconThere are 2 versions of this paper

Date Written: March 27, 2017

Abstract

Past work has shown that failure tolerance by principals has the potential to stimulate innovation, but has not examined how this affects which projects principals will start. We demonstrate that failure tolerance has an equilibrium price ― in terms of an investor's required share of equity ― that increases in the level of radical innovation. Financiers with investment strategies that tolerate early failure will endogenously choose to fund less radical innovations, while the most radical innovations (for whom the price of failure tolerance is too high) can only be started by investors who are not failure tolerant. Since policies to stimulate innovation must often be set before specific investments in innovative projects are made, this creates a tradeoff between a policy that encourages experimentation ex-post and one that funds experimental projects ex-ante. In equilibrium it is possible that all competing financiers choose to offer failure tolerant contracts to attract entrepreneurs, leaving no capital to fund the most radical, experimental projects in the economy. The impact of different innovation policies can help to explain who finances radical innovations, and when and where radical innovation occurs.

Keywords: Financing Innovation, Failure Tolerance, Abandonment Options

JEL Classification: G24, O31

Suggested Citation

Nanda, Ramana and Rhodes-Kropf, Matthew, Innovation Policies (March 27, 2017). AiSM Special Issue on Entrepreneurship, Innovation and Platforms, Forthcoming; Harvard Business School Entrepreneurial Management Working Paper No. 13-038. Available at SSRN: https://ssrn.com/abstract=2187931 or http://dx.doi.org/10.2139/ssrn.2187931

Ramana Nanda (Contact Author)

Harvard University - Entrepreneurial Management Unit ( email )

Boston, MA 02163
United States

HOME PAGE: http://www.people.hbs.edu/rnanda

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit ( email )

Soldiers Field Road
Rock Center 312
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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