Information Acquisition and Innovation under Competitive Pressure

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. Recent empirical papers point to an inverted-U shape relationship between competition and innovation. Our paper offers theoretical support to these results while employing a more accurate definition of innovation than the previous literature; more precisely, we isolate innovation from riskless technological progress. The firms in our model learn of an invention and decide on whether and when to innovate. In making this decision, firms face a trade-off between seeking a first-mover advantage and waiting to acquire more information. By recognizing that a firm can intensify its innovative activity on two dimensions, a temporal and a quantitative one, we show that firms solve this trade-off precisely so as to generate the inverted-U shape relationship. When the competition in the pre innovation market is sufficiently high, the level of competition in the post innovation market is endogenous. We investigate the welfare effects of innovation under competitive pressure and find conditions that determine the socially optimal level of competition. We study the effects that the degree of technological spread in the industry has on innovation and highlight the roles that strategic uncertainty and the discreteness of the information acquisition process play in this context.