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Organization of Innovation and Capital Markets

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  • Orman, Cuneyt

Abstract

There has been an explosion of innovation backed by venture capital since late 1970’s. Nonetheless, a great deal of innovation still occurs within large companies. In this paper, I investigate the factors that determine when innovation is performed by venture-backed firms and when by large companies. To this end, I develop a theoretical model in which development of new technologies and products requires the collaboration of researchers, executives, and suppliers of capital. I focus on the two-tier agency problem designed to provide simultaneously the right kinds of incentives for researchers and executives. I find that if capital markets function perfectly, it is optimal for innovation to be conducted by venture-backed firms: Specialization implicit in venture form of organization mitigates two-tier agency problems. If capital markets are sufficiently imperfect, however, it is optimal for innovation to be performed by large companies: they can use cheaper internal funds to finance innovation. I finally point to the role of policy in improving capital markets and hence innovation performance.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 22848.

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Date of creation: 31 May 2008
Date of revision: 21 May 2010
Handle: RePEc:pra:mprapa:22848

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Related research

Keywords: Innovation; Organizational Form; Financial Imperfections; Venture Capital;

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References

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  1. James M. Poterba, 1988. "Venture Capital and Capital Gains Taxation," Working papers 508, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Sah, Raaj Kumar & Stiglitz, Joseph E, 1986. "The Architecture of Economic Systems: Hierarchies and Polyarchies," American Economic Review, American Economic Association, vol. 76(4), pages 716-27, September.
  3. Aghion, Philippe & Tirole, Jean, 1997. "Formal and Real Authority in Organizations," Scholarly Articles 4554125, Harvard University Department of Economics.
  4. Radner, Roy, 1993. "The Organization of Decentralized Information Processing," Econometrica, Econometric Society, vol. 61(5), pages 1109-46, September.
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  7. Jeremy C. Stein, 1995. "Internal Capital Markets and the Competition for Corporate Resources," NBER Working Papers 5101, National Bureau of Economic Research, Inc.
  8. Sanford J Grossman & Oliver D Hart, 2001. "An Analysis of the Principal-Agent Problem," Levine's Working Paper Archive 391749000000000339, David K. Levine.
  9. Rajan, Raghuram G & Zingales, Luigi, 2003. "Banks and Markets: the Changing Character of European Finance," CEPR Discussion Papers 3865, C.E.P.R. Discussion Papers.
  10. Romain, Astrid & Pottelsberghe de la Potterie, Bruno van, 2003. "The Economic Impact of Venture Capital," IIR Working Paper 03-20, Institute of Innovation Research, Hitotsubashi University.
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  14. Holmstrom, Bengt, 1989. "Agency costs and innovation," Journal of Economic Behavior & Organization, Elsevier, vol. 12(3), pages 305-327, December.
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  16. Raghuram G. Rajan & Luigi Zingales, . "Financial Dependence and Growth," CRSP working papers 344, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  17. Bharant N. Anand & Alexander Galetovic, 1998. "Weak Property Rights and hold-up in R&D," Documentos de Trabajo 39, Centro de Economía Aplicada, Universidad de Chile.
  18. Hirukawa, Masayuki & Ueda, Masako, 2008. "Venture Capital and Industrial ''Innovation''," CEPR Discussion Papers 7089, C.E.P.R. Discussion Papers.
  19. Demirguc-Kunt, Asli & Levine, Ross, 2008. "Finance, financial sector policies, and long-run growth," Policy Research Working Paper Series 4469, The World Bank.
  20. Rotemberg, Julio J & Saloner, Garth, 1994. "Benefits of Narrow Business Strategies," American Economic Review, American Economic Association, vol. 84(5), pages 1330-49, December.
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  22. Hellmann, Thomas & Puri, Manju, 2000. "The Interaction between Product Market and Financing Strategy: The Role of Venture Capital," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 959-84.
  23. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
  24. Laura Bottazzi & Marco da Rin, 2003. "Financing Entrepreneurial Firms in Europe: Facts, Issues, and Research Agenda," CESifo Working Paper Series 958, CESifo Group Munich.
  25. Holmström, Bengt, 1989. "Agency Costs and Innovation," Working Paper Series 214, Research Institute of Industrial Economics.
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