Financing of Competing Projects with Venture Capital
AbstractWe analyze innovation race in a moral hazard setting. We develop a model in which two competing entrepreneurs work independently on the same project. The entrepreneurs do not possess any wealth of their own and their research is financed by a venture capitalist. The project, if successful, generates a prize, which is to be shared between the winning entrepreneur and the venture capitalist. The venture capitalist cannot observe the allocation of funds he provides, which creates a moral hazard problem. We compare a competitive setting with a benchmark case where the venture capitalist finances only one entrepreneur. We show that the venture capitalist can increase the efficiency of research (hence, his own expected profit from investments) and alleviate the moral hazard problem if he finances both entrepreneurs. This conclusion is unambiguous, when the entrepreneurs are at the same (the last) stage of R&D. It holds for a reasonably large range of parameters, when the entrepreneurs are at different stages of R&D.
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Bibliographic InfoPaper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse37_2005.
Date of creation: Dec 2005
Date of revision:
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venture capital; moral hazard; optimal contract; innovation race;
Find related papers by JEL classification:
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
- O31 - Economic Development, Technological Change, and Growth - - Technological Change; Research and Development; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-01-01 (All new papers)
- NEP-CFN-2006-01-01 (Corporate Finance)
- NEP-ENT-2006-01-01 (Entrepreneurship)
- NEP-FMK-2006-01-01 (Financial Markets)
- NEP-INO-2006-01-01 (Innovation)
- NEP-MIC-2006-01-01 (Microeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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