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Investment in ideas when genius and madness look alike

James Campbell

Economics Bulletin, 2019, vol. 39, issue 2, 947-953

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.

Keywords: innovation; noisy quality signals; investor funding; entrepreneurship; investment returns (search for similar items in EconPapers)
JEL-codes: D8 L2 (search for similar items in EconPapers)
Date: 2019-04-25
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