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Innovation and the Financial Guillotine

Ramana Nanda () and Matthew Rhodes-Kropf ()

No 19379, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Our paper demonstrates that while failure tolerance by investors may encourage potential entrepreneurs to innovate, financiers with investment strategies that tolerate early failure endogenously choose to fund less radical innovations. Failure tolerance as an equilibrium price that increases in the level of experimentation. More experimental projects that don't generate enough to pay the price cannot be started. In equilibrium all competing financiers may choose to offer failure tolerant contracts to attract entrepreneurs, leaving no capital to fund the most radical, experimental projects. The tradeoff between failure tolerance and a sharp guillotine helps explain when and where radical innovation occurs.

JEL-codes: G24 G39 O31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-ent, nep-ino, nep-knm and nep-ppm
Date: 2013-08
Note: CF PR
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