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Innovation Policies

Author

Listed:
  • Ramana Nanda

    () (Harvard Business School, Entrepreneurial Management Unit)

  • Matthew Rhodes-Kropf

    () (Harvard Business School, Entrepreneurial Management Unit)

Abstract

Past work has shown that failure tolerance by principals has the potential to stimulate innovation, but has not examined how this affects which projects 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 radical innovation. Financiers with investment strategies that tolerate early failure will endogenously choose to fund less radical innovations, while the most radical innovations (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.

Suggested Citation

  • Ramana Nanda & Matthew Rhodes-Kropf, 2012. "Innovation Policies," Harvard Business School Working Papers 13-038, Harvard Business School, revised Mar 2017.
  • Handle: RePEc:hbs:wpaper:13-038
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Ramana Nanda & William R. Kerr, 2015. "Financing Innovation," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 445-462, December.
    2. Hellmann, Thomas & Thiele, Veikko, 2015. "Friends or foes? The interrelationship between angel and venture capital markets," Journal of Financial Economics, Elsevier, vol. 115(3), pages 639-653.
    3. William R. Kerr & Ramana Nanda & Matthew Rhodes-Kropf, 2014. "Entrepreneurship as Experimentation," Journal of Economic Perspectives, American Economic Association, vol. 28(3), pages 25-48, Summer.
    4. Dan ANDREWS & Chiara CRISCUOLO & Dirk PILAT, 2015. "The Future of Productivity Improving the Diffusion of Technology and Knowledge," Communications & Strategies, IDATE, Com&Strat dept., vol. 1(100), pages 85-105, 4th quart.
    5. repec:bof:bofrdp:urn:nbn:fi:bof-201512141480 is not listed on IDEAS

    More about this item

    Keywords

    Financing Innovation; Failure Tolerance; Abandonment Options;

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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