Innovation in Firms: Experimentation and Strategic Communication

Abstract

How is innovation affected by information asymmetry within firms? A CEO privately
learns valuable project information and communicates it strategically to the board. The board decides how much to invest and which project to continue with going forward. This project guidance motive can result in more experimentation than under symmetric information. Strategic communication creates innovation convexity, favoring radical or incremental over moderate experimentation. Surprisingly, experimentation may be optimal even if, conditional on an early success, it offers no better future project prospects than a routine project. Overall, information frictions within firms can alleviate the underprovision of innovation due to free-riding.

Keywords: innovation, capital budgeting, exploration versus exploitation, delegation, strategic communication

JEL Classification: G31, M21, D21, D83