Organization of Innovation and Capital Markets

Orman, Cuneyt (2008): Organization of Innovation and Capital Markets.

Abstract

There has been an explosion of innovation backed by venture capital since late 1970’s. Nonetheless, a great deal of innovation still occurs within large companies. In this paper, I investigate the factors that determine when innovation is performed by venture-backed firms and when by large companies. To this end, I develop a theoretical model in which development of new technologies and products requires the collaboration of researchers, executives, and suppliers of capital. I focus on the two-tier agency problem designed to provide simultaneously the right kinds of incentives for researchers and executives. I find that if capital markets function perfectly, it is optimal for innovation to be conducted by venture-backed firms: Specialization implicit in venture form of organization mitigates two-tier agency problems. If capital markets are sufficiently imperfect, however, it is optimal for innovation to be performed by large companies: they can use cheaper internal funds to finance innovation. I finally point to the role of policy in improving capital markets and hence innovation performance.

• Item Type: MPRA Paper
• Language: English
• Keywords: Innovation, Organizational Form, Financial Imperfections, Venture Capital
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory; D - Microeconomics > D2 - Production and Organizations; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; O - Economic Development, Innovation, Technological Change, and Growth > O3 - Innovation ; Research and Development ; Technological Change ; Intellectual Property Rights > O32 - Management of Technological Innovation and R&D; G - Financial Economics > G2 - Financial Institutions and Services > G24 - Investment Banking ; Venture Capital ; Brokerage ; Ratings and Ratings Agencies

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