The dynamics of innovation and risk
We study the dynamics of an innovative industry when agents learn about the likelihood of negative shocks. Managers can exert risk-prevention effort to mitigate the consequences of shocks. If no shock occurs, confidence improves, attracting managers to the innovative sector. But, when condence becomes high, inefficient managers exerting low risk-prevention effort also enter. This stimulates growth, while reducing risk-prevention. The longer the boom, the larger the losses if a shock occurs. While these dynamics arise in the first-best, asymmetric information generates excessive entry of inefficient managers, earning informational rents, inflating the innovative sector and increasing its vulnerability.
|Date of creation:||Oct 2013|
|Date of revision:|
|Publication status:||Published in The Review of Financial Studies, 2014.|
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