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Innovation and the Financial Guillotine

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  • Ramana Nanda
  • Matthew Rhodes-Kropf

Abstract

Our paper demonstrates that while failure tolerance by investors may encourage potential entrepreneurs to innovate, financiers with investment strategies that tolerate early failure endogenously choose to fund less radical innovations. Failure tolerance as an equilibrium price that increases in the level of experimentation. More experimental projects that don't generate enough to pay the price cannot be started. In equilibrium all competing financiers may choose to offer failure tolerant contracts to attract entrepreneurs, leaving no capital to fund the most radical, experimental projects. The tradeoff between failure tolerance and a sharp guillotine helps explain when and where radical innovation occurs.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19379.

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Date of creation: Aug 2013
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Handle: RePEc:nbr:nberwo:19379

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Cited by:
  1. Ramana Nanda & Matthew Rhodes-Kropf, 2011. "Investment Cycles and Startup Innovation," Harvard Business School Working Papers 12-032, Harvard Business School, revised Dec 2012.

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