Crossing the Valley of Death: An R&D Race with Moral Hazard and Multiple Prizes
59 Pages Posted: 23 Apr 2020 Last revised: 3 Aug 2020
Date Written: July 9, 2020
This paper analyzes moral hazard in market entry competition between externally funded firms. A finite number of entrepreneurs seek to advance their promising yet loss-making startups into a profitable market. Market entry requires a breakthrough opportunity, which may be obtained at a fixed and commonly known rate when engaging in costly R&D. Entrepreneurs are cash-constrained and rely on external funding. R&D is not contractible and entrepreneurs can choose to covertly divert some of the investors' funds to their own benefit instead. To overcome moral hazard, investors set deadlines up to which they provide funding. The profitable market may accommodate more than one firm. Early-mover advantages in the profitable market are linked to asymmetric deadlines, resulting in staggered exit from the race. Late-mover advantages tend to induce symmetric deadlines, leading to shakeouts. These comparative statics result from the interplay between a competition and a free-riding effect that arise from multiple prizes together with moral hazard.
Keywords: Continuous-Time Race, Multiple Prizes, Market Entry, External Funding, Moral Hazard, Multiple Principals
JEL Classification: C73, D86, O3
Suggested Citation: Suggested Citation