Innovation and the Financial Guillotine

58 Pages Posted: 30 Aug 2013 Last revised: 14 Mar 2015

See all articles by Ramana Nanda

Ramana Nanda

Harvard University - Entrepreneurial Management Unit

Matthew Rhodes-Kropf

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

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Date Written: August 2013

Abstract

Our paper demonstrates that while failure tolerance by investors may encourage potential entrepreneurs to innovate, financiers with investment strategies that tolerate early failure endogenously choose to fund less radical innovations. Failure tolerance as an equilibrium price that increases in the level of experimentation. More experimental projects that don't generate enough to pay the price cannot be started. In equilibrium all competing financiers may choose to offer failure tolerant contracts to attract entrepreneurs, leaving no capital to fund the most radical, experimental projects. The tradeoff between failure tolerance and a sharp guillotine helps explain when and where radical innovation occurs.

Suggested Citation

Nanda, Ramana and Rhodes-Kropf, Matthew, Innovation and the Financial Guillotine (August 2013). NBER Working Paper No. w19379. Available at SSRN: https://ssrn.com/abstract=2318282

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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