The Effects of Competition and Monitoring on R&D Investment: A Dynamic Approach
39 Pages Posted: 31 Jul 2017
Date Written: July 25, 2017
We examine a dynamic model of R&D investment by competing firms with an uncertain payout and uncertain time to development success. The effect of competition on R&D investment depends critically on whether firms are able to monitor, and react to, each other's actions. In the absence of monitoring, competition speeds up investment and erodes option values. When monitoring is allowed, the Pareto-dominant closed-loop equilibrium is identical to the first-best cooperative equilibrium, with investment that is increasingly postponed as more firms enter the market. A novel approach, solving a sequence of pure-jump equilibria, is used to obtain the equilibrium in the Brownian limit.
Keywords: real options; Brownian motion; Nash equilibrium; open loop; closed loop
JEL Classification: Q31
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