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Innovation Policies

  • Ramana Nanda

    ()

    (Harvard Business School, Entrepreneurial Management Unit)

  • Matthew Rhodes-Kropf

    ()

    (Harvard Business School, Entrepreneurial Management Unit)

Past work has shown that failure tolerance by principals has the potential to stimulate innovation, but has not examined how this affects which pro- jects principals will start. We demonstrate that failure tolerance has an equilibrium price ? in terms of an investor's required share of equity ? that increases in the level of experimentation. Financiers with investment strategies that tolerate early failure will endogenously choose to fund less radical innovations, while the most experimental projects (for whom the price of failure tolerance is too high) can only be started by investors who are not failure tolerant. Since policies to stimulate innovation must often be set before specific investments in innovative projects are made, this creates a tradeoff between a policy that encourages experimentation ex-post and one that funds experimental projects ex-ante. In equilibrium it is possible that all competing financiers choose to offer failure tolerant contracts to attract entrepreneurs, leaving no capital to fund the most radical, experimental projects in the economy. The impact of different innovation policies can help to explain who finances radical innovations, and when and where radical innovation occurs.

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File URL: http://www.hbs.edu/faculty/pages/download.aspx?name=13-038.pdf
File Function: Revised version, 2017
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Paper provided by Harvard Business School in its series Harvard Business School Working Papers with number 13-038.

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Length: 52 pages
Date of creation: Oct 2012
Date of revision: Jan 2017
Handle: RePEc:hbs:wpaper:13-038
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