Issue 2 – Special Issue on Innovation Economics II

Volume 24 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Summer 2015

The 2011 America Invents Act: Does it Undermine Innovation?

Kaz Miyagawa
With the 2011 America Invents Act, the United States discarded its century-old first-to-invent patent-awarding system in favor of a first-to-file rule. Critics have argued that the first-to-file rule rewards speed in patent applications rather than creativity, thereby undermining innovation. We evaluate this concern within a dynamic model of a patent race, and find first-to-invent (weakly) more conducive to innovation than first-to-file. Defending prior users’ rights can promote both pro- and anti-R&D effect of a switch to first-to-file.

Business Partners: Complementary Assets, Financing, and Invention Commercialization

Thomas Åstebro and Carlos J. Serrano
This paper assesses the relative importance of the complementary assets and financial capital that business partners may add to the original inventor-entrepreneur. Projects run by partnerships were five times as likely to reach commercialization as those without business partners, and they had mean revenues approximately 10 times as great as projects run by solo entrepreneurs. These gross differences may be due both to partners impacting business success that is, who the particular partners were, and to selection of the type of project or of whom to select as a partner. After controlling for selection effects and observed/unobserved heterogeneity, the smallest estimate of partners' complementary assets approximately doubles the probability of commercialization and increases expected revenues by 29% at the sample mean. Our findings suggest that a critical policy option to increase commercialization rates and revenues for early-stage businesses is to support the market for finding skilled partners.

Crowdfunding: Geography, Social Networks, and the Timing of Investment Decisions

Ajay Agrawal, Christian Catalini, and Avi Goldfarb
We examine a crowdfunding platform that connects artists with funders. Although the Internet reduces many distance-related frictions, local and distant funders exhibit different funding patterns. Local funders appear less responsive to information about the cumulative funds raised by an artist. However, this distance effect appears to proxy for a social effect: it is largely explained by funders who likely have an offline social relationship with the artist (“friends and family”). Yet, this social effect does not persist past the first investment, suggesting that it may be driven by an activity like search but not monitoring. Thus, although the platform seems to diminish many distance-sensitive costs, it does not eliminate all of them. These findings provide a deeper understanding of the abilities and limitations of online markets to facilitate transactions and convey information between buyers and sellers with varying degrees of social connectedness.

Executive Pay, Innovation, and Risk-Taking

Volker Laux
This paper analyzes the optimal equity pay mix in a setting in which executives face career concerns and must be motivated to search for innovative investment ideas and to make appropriate decisions regarding whether to pursue the uncovered idea. I show that, depending on the value of the firm's potential growth opportunities and the CEO's concern about being fired, the CEO is either tempted to overinvest in risky ideas (excessive risk-taking) or underinvest in risky ideas (excessive conservatism). The optimal pay package consists of stock options, to encourage the discovery of innovative ideas, and either restricted stock, to combat excessive risk-taking, or severance pay, to combat excessive conservatism. The model provides new empirical predictions relating executive pay arrangements to the importance of innovation and career concerns and analyzes how the change in the economic environment caused by the current financial crisis might change the optimal mix of stock options, restricted stock, and severance pay.

Investment Incentives in Open-Source and Proprietary Two-Sided Platforms

Ramon Casadesus-Masanell and Gastón Llanes
We study incentives to invest in platform quality in open-source and proprietary two-sided platforms. Open platforms have open access, and developers invest to improve the platform. Proprietary platforms have closed access, and investment is done by the platform owner. We present five main results. First, open platforms may benefit from limited developer access. Second, an open platform may lead to higher investment than a proprietary platform. Third, opening one side of a proprietary platform may lower incentives to invest in platform quality. Fourth, the structure of access prices of the proprietary platform depends on (i) how changes in the number of developers affect the incentives to invest in the open platform, and (ii) how investment in the open platform affects the revenues of the proprietary platform. Finally, a proprietary platform may benefit from higher investment in the open platform. This result helps to explain why the owner of a proprietary platform such as Microsoft has chosen to contribute to the development of Linux.

Information Acquisition and Innovation under Competitive Pressure

Andrei Barbos
This paper studies information acquisition under competitive pressure and proposes a model to examine the relationship between product market competition and the level of innovative activity in an industry. Our paper offers theoretical support for recent empirical results that point to an inverted-U shape relationship between competition and innovation. The model presents an optimal timing decision problem where a firm endowed with an idea trades the benefits of waiting for additional information on whether this idea can be converted into a successful project against the cost of delaying innovation: a given firm's profit following innovation is decreasing in the number of firms that invested at earlier dates. By recognizing that a firm can intensify its innovative activity on two dimensions, a risk dimension and a quantitative dimension, we show that firms solve this trade-off precisely so as to generate the inverted-U shape relationship. The dynamic setup of our model offers insights not just in the cross-section on the relationship between competition and innovation, but also intertemporally on the optimal timing of innovation at firm level.

Optimal Production Channel for Private Labels: Too Much or Too Little Innovation?

Claire Chambolle, Clémence Christin, and Guy Meunier
We analyze the impact of the private label production channel on innovation. A retailer may either choose to integrate backward with a small firm (insourcing) or rely on a national brand manufacturer (outsourcing) to produce its private label. The trade-off between insourcing and outsourcing strategies is a choice between too much or too little innovation (i.e., quality investment) on the private label. When insourcing, an outside-option effect leads the retailer to overinvest to increase its buyer power. When outsourcing, a hold-up effect leads to underinvestment. In addition, selecting the national brand manufacturer may create economies of scale that spur innovation.

Entering New Markets in the Presence of Competition: Price Discrimination versus Cannibalization

Ralph Siebert
This study focuses on firms' optimal entry strategies in new markets when products are differentiated in quality. We are interested in investigating how many products of different qualities firms should introduce into an empty market. One profitable strategy is that firms introduce multiple products to proliferate the product space such that entry by competitors is deterred. Our results show that firms' optimal strategy to enter new markets is described by introducing a single product only. Firms differentiate their products not only toward their rivals' products to soften price competition, but also toward their own goods in order to avoid cannibalizing their own (high quality) product demand.

Unbundling Technology Adoption and tfp at the Firm Level: Do Intangibles Matter?

Michele Battisti, Filippo Belloc, and Massimo Del Gatto
We use a panel of European firms to investigate the relationship between intangible assets and productivity. We distinguish between total factor productivity (tfp) and technology adoption, whereas standard estimations consider only a notion of productivity that conflates the two effects. Although we are unable to address simultaneity, we allow for the existence of multiple technologies within sectors through a mixture model approach. We find that intangible assets have nonnegligible effects that both push firms toward better technologies (technology adoption effects) and allow for more efficient exploitation of a given technology (tfp effects).

Investment, Duration, and Exit Strategies for Corporate and Independent Venture Capital-Backed Start-Ups

Bing Guo, Yun Lou, and David Pérez-Castrillo
We propose a model of investment, duration, and exit strategies for start-ups backed by venture capital (VC) funds that accounts for the high level of uncertainty, the asymmetry of information between insiders and outsiders, and the discount rate. Our analysis predicts that start-ups backed by corporate VC funds remain for a longer period of time before exiting and receive larger investment amounts than those financed by independent VC funds. Although a longer duration leads to a higher likelihood of an exit through an acquisition, a larger investment increases the probability of an IPO exit. These predictions find strong empirical support.