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Investment in ideas when genius and madness look alike

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  • James D. Campbell

    (Providence College)

Abstract

I study a situation in which investors use a noisy signal of the quality of an entrepreneur's idea in order to decide how much to invest. However, while ideas of middling quality are quite easy to evaluate, the most ingenious ideas are hard to distinguish from the most terrible ideas. This results in systematic over-investment in the very worst ideas and under-investment in the very best ideas. If the entrepreneur has a threshold for what offer of funding they are willing to accept, the very worst ideas are more likely to be funded than much better ideas. Some known quirks of investment return patters can be explained in this framework, without asymmetric information.

Suggested Citation

  • James D. Campbell, 2019. "Investment in ideas when genius and madness look alike," Economics Bulletin, AccessEcon, vol. 39(2), pages 947-953.
    • Handle: RePEc:ebl:ecbull:eb-19-00037
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    References listed on IDEAS

    as
    1. Michelle Lowry & Micah S. Officer & G. William Schwert, 2010. "The Variability of IPO Initial Returns," Journal of Finance, American Finance Association, vol. 65(2), pages 425-465, April.
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    3. Allen, Stephen A. & Hevert, Kathleen T., 2007. "Venture capital investing by information technology companies: Did it pay?," Journal of Business Venturing, Elsevier, vol. 22(2), pages 262-282, March.
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    More about this item

    Keywords

    innovation; noisy quality signals; investor funding; entrepreneurship; investment returns;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior

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